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Wednesday, April 21, 2010

Marion Post Wolcott The Agriculture Lobby July 1940"Mulattoes returning from town with groceries and supplies near Melrose, Natchitoches Parish, Louisiana"

Ilargi: The US Senate this week will debate Chris Dodd’s bank reform proposals. Folded into the bill that is supposed to come out of the debate, will be a separate bill on derivatives. Which, just off the press, apparently was voted in. By the Senate Agriculture Committee. Who else? You thought the Banking, Housing, and Urban Affairs or Economic Policy or Financial Institutions or Securities, Insurance, and Investment committees might have been more appropriate? You’re so new school. In the US, that's not how they do things.

So not banking and financial services committees , but instead the Senate Agriculture Committee and its chair, Senator Blanche Lincoln, D-Arkansas, (who, judging by her name, may well have survived marriages to to both Ulysses Grant and Clark Gable in her younger years; yeah, I know she's only 49, but that name!), and who introduced the bill that will prevent banks from "direct" derivatives trading. By the way, Wall Street firms raised $60,000 at two fund-raisers for Blanche's re-election campaign so far this year. That may have to do?!

Now, we all know that not even the Senate banking committees, the supposed experts, have more than a faintest idea what they talk about when it comes to derivatives. Let alone the Agriculture Committee. It’s just that farmers first started to use the things to protect themselves from crop failures, and that’s why Blanche Lincoln rules the day. And for all I know, that may not be such a bad thing. Get some folks in that there decision making process who don’t have their noses perpetually and exclusively stuck up Wall Street asses. Is what I’m saying. How could that hurt?

Of course, than "danger" was long foreseen by the Goldmans and Dimons of the country, and so K-Street invaded the committee. Allow me, please, to give you Edward Wyatt and Eric Lichtblau at the New York Times on the topic for a moment:

Jamie Dimon, the chief executive of JPMorgan Chase, left no doubt about the consequences if Congress cracked down on his bank’s immense business in derivatives. "It will be negative," he said. "Depending on the real detail, it could be $700 million or a couple billion dollars." With so much money at stake, it is not surprising that more than 1,500 lobbyists, executives, bankers and others have made their way to the Senate committee that on Wednesday will take up legislation to rein in derivatives [..]

The forum for all this attention is not the usual banking and financial services committees, but rather the Senate Agriculture Committee, a group more accustomed to dealing with farm subsidies and national forest boundaries than with the more obscure corners of Wall Street. A main weapon being wielded to fight the battle, of course, is money. Agriculture Committee members have received $22.8 million in this election cycle from people and organizations affiliated with financial, insurance and real estate companies — two and a half times what they received from agricultural donors, according to the Center for Responsive Politics.

Much of that lobbying has centered on Senator Blanche Lincoln, the Arkansas Democrat who is the committee’s chairwoman and who last week introduced the bill that would prevent banks from trading derivatives directly. The daughter of a sixth-generation rice farmer, she has found herself navigating a dangerous channel between Wall Street firms, which raised $60,000 at two fund-raisers for her re-election campaign so far this year, and her constituents, many of whom want a crackdown on the speculation that led to the financial crisis.

The committee will be the main arena for the derivatives fight for reasons dating to an era when farming was more important to the nation’s economy than finance. In their simplest form, derivatives can provide financial protection on the value of an investment or commodity. For example, by putting up a relatively small amount of money, a farmer could buy a derivative known as a forward or futures contract that would guarantee a set price for crops and thereby guard against ruinous price swings between planting and harvest.[..]

Wall Street bankers were stunned by the most aggressive portion of Ms. Lincoln’s bill, one that is opposed even by the Obama administration. That proposal would essentially ban banks from being dealers in swaps or other derivatives by taking away their access to federal deposit insurance and their ability to borrow from the Federal Reserve if they kept those businesses.

Mrs. Lincoln, who is facing a tough primary challenge in May to get to the general election in November, said in an interview that she was not sure why the administration did not fully agree with her derivatives approach. "The people of Arkansas never again want to have to foot the bill for what happens on Wall Street," she said. "If banks want to be in that kind of risky business, they should have to separate it off in a way that lowers the systemic risk."[..]

Ilargi: Atta girl, Blanche. The same article has a priceless Geithner gem that I wouldn’t want you to miss:

"The best that we can do for the American people is to put in place rules that will prevent firms from taking this risk again, make sure we protect the taxpayer, bring derivatives out of the dark — that’s what we can do, " said Timothy F. Geithner, the Treasury secretary.

Ilargi: If that’s the best you think you can do for the American people, Tim, you’re way out of your league. You and your pals, Summers, Rubin, and yes, Obama, if it were the American people you were worried about, you could for instance break up the Wall Street banks engaged in derivatives trading into tiny slivers of their former selves. You could ban all derivatives for anyone who has no skin in the game, i.e. who owns no piece of the underlying assets the bets are tied to. You could fight to establish a 2010 version of Glass Steagall. And you could also fight for a 2010 Pecora Commission. Just to name some options. So don't give us that meaningless drivel. Be a man, and state openly who’s your daddy.

So where is the main problem? Why can't the US get any initiative worthy of the name going 2,5 years after the walls of finance got crumbling that would do what the US government indeed COULD do, let's see, 77 years ago.

Look no further than the 1500 banking lobbyists who descended upon the Senate Agricultural Committee this week (oops, they just lost to Blanche). They weren’t there to bother Democratic Senator Carter Glass of Virginia or Democratic Congressman Henry B. Steagall of Alabama back in the day. I’m thinking both Glass and Steagall had a pretty good notion for themselves as to what they were talking about. And I know today's guys do not. Which is why Blanche Lincoln may be just what the country needs. You don’t have to know how a crime is committed to realize that murder is wrong.

And then there’s the campaign contributions. The finance sector is the second biggest contributor when it comes to donations to Washington, behind the health care industry. What does that say about the thruthiness and impartiality of the finance reform bill before us? For that matter, what does it say about the health care bill that just passed?

It's not that hard, is it? What this says is that the US government, what ever party it belongs to, can no longer effectively legislate. That after the braindead bickering, elbowing and vying for the brightest spot in the sun, the peacocks do what their biggest donors want them to. President Obama got $15 million from Wall Street, $1 million from Goldman Sachs alone, in his 2008 campaign. How can you possibly think he would represent you AGAINST the people who gave him all that money? Look, the very people who write the rules, who are supposed to make sure you will never have to bail out Goldman Sachs or Bank of America, are on the payroll of these banks. And they don't even try to hide it. It’s the new normal.

And so you will have a bank reform bill dictated by the banks, just as you already have a health care bill dictated by that industry. And no, it's not all-out rape and vultures, that’s not what they do, they instead look for something that will make you feel like it's your own, while at the same time all your furniture except the chair you sit in is dragged out of your home behind your back. Face it, as long as multi-billion dollar special interests and their lobbyists have access to Capitol Hill and the White House, and you do not, the game is rigged.

And as long as money is allowed to shape America politics and policies, it will do so. What are you going to do about it? The guys and girls you elected to represent your interests are more beholden to the interests of the people who paid for the campaign that made you elect them, than they are to you. This will not change of its own accord, it’s a closed and vicious circle. Here’s Brody Mullins in the Wall Street Journal:

Companies and executives in the financial sector are the second-leading source of campaign money for all candidates for Congress, behind the health-care industry. Democrats have long received the lion's share of campaign donations from Wall Street. President Barack Obama received nearly $15 million in the 2008 presidential campaign from the securities and investment industry, according to the Center for Responsive Politics. Republicans have noted that Goldman Sachs employees gave Mr. Obama nearly $1 million during the campaign, making the company his second-largest source of donations. Mr. Obama hasn't said if he would return the Goldman donations in the wake of recent allegations against the company.[..]

The financial-services legislation seeks to create greater government oversight of the industry and to regulate some practices implicated in the recent financial collapse. Democrats in the House passed a version of the legislation last year over Republican opposition. In the Senate, Democrats overcame Republican resistance to pass the bill through the Banking Committee earlier this year. The bill may come to the Senate floor this week or next. Sen. Charles Schumer (D., N.Y.), a member of the Banking Committee, raised money for the Senate Democrats' campaign arm at an April event sponsored by John Paulson, the New York hedge manager at the center of the government's fraud case against Goldman Sachs.

Mr. Schumer is "one of the few members of Congress who has consistently supported the hedge-fund industry," said Mr. Paulson in a letter inviting other Wall Street executives to the event. Neither Mr. Paulson nor his firm has been charged with wrongdoing. Sen. Richard Shelby of Alabama, the top Republican on the Banking Committee, has attended at least a half-dozen fund-raisers in the last few months with lobbyists and executives, according to invitations viewed by The Wall Street Journal.

On March 11, Mr. Shelby was scheduled to attend a $1,000-a-person breakfast fund-raiser at the offices of Washington lobbying firm K&L Gates LLP, the Financial Accounting Foundation and Pitney Bowes, which is lobbying aspects of the financial overhaul. A few hours later, he was to attend a $1,000-a-person lunch at the private 116 Club on Capitol Hill with a slate of lobbyists for other Wall Street firms. Mr. Shelby's campaign-finance reports suggest that fund-raising on Wall Street spiked as the legislative activity on Capitol Hill increased. In February, Mr. Shelby received $55,000 from Wall Street political action committees and executives, according to his most recent campaign report.

In March, when Senate negotiations intensified on the financial-services bill, Mr. Shelby received $200,000 in Wall Street donations, including $50,000 from employees of J.P. Morgan and Morgan Stanley. "Those who contribute to the senator's campaign do so in full support of the senator's philosophy, and not the other way around," a spokesman for Mr. Shelby said.

In a situation like this, it's simply not possible to get sufficient and effective legislation. And no, I'm not sure I know what to do about it either, short of (lots of) pitchforks. But I do think it’s important you realize this for a fact. That in US politics, there's two dogs fighting for a mighty fat bone, and there's no third dog in sight to run away with it. In fact, the two dogs fighting is just a spectacle designed to divert your attention from the backroom deals and envelopes changing hands that are the real action.

There may be a tad more Goldman backlash, but what can you expect a government to do versus a bank that it has declared too big to fail? Fine it a billions dollars? Who do you think will end up paying that fine? After all, what's another bilion for you, affluent taxpayer?

All that awaits us, since "we" have committed ourselves to the idea that there's too big to fail institutions (I still don’t buy that, let's try, let's see how true that is, let's start with just one), is more bail outs, and hence more costs for the American people. And who's going to halt that process, who’ll say enough is enough? Well, no-one, not as long as you elect them for the very reason that they broadcast a million campaign ads paid for by the very banks they should fail. The people you elect should be YOUR lobbyists, to stand up against the big money lobby. But do you really think that’s what they do? Of course not, they owe their comfy seats to big money!

They should, President Obama first, throw the big money lobby out of the temple. But I say they won’t, because they owe their positions to that lobby.

And let me tell you one thing, American taxpayer: with all the bail-outs and help homeowners programs and misfiring unemployment plans, you have very precious little money left. And if you believe in God, you should heed this warning going forward:

If Goldman Sachs is doing God’s work, then the American people can’t afford God’s work anymore.

The attention of policymakers and economists is trained mostly on a looming inflation threat, the drawback you typically associate with enormous amounts of liquidity pumped into the financial system and an economy rebounding from a severe recession. A negligible 0.1% rise in the March consumer price index and comments from the Federal Reserve that interest rates will remain very low for an extended time don't appear to confirm that risk, however.

Some economists and analysts see reasons to worry about the opposite scenario—a period of deflation if companies feel compelled to lower prices to jump-start demand in a sluggish economic recovery burdened by high unemployment. Consumers initially embrace falling prices, but if it becomes deep and pervasive enough, deflation will eventually push employers to cut wages and ax jobs, driving worried consumers into complete retreat. Perhaps most dangerous, deflation hikes the cost of repaying debt by boosting the value of the dollar.

That the value of the U.S. dollar is down 30% from its peak several years ago should have been sufficient to restore the U.S. to a fairly competitive trade position, even given the euro's recent decline, says Barry Bosworth, senior fellow at the Brookings Institution in Washington. But U.S. exports, which were robust in the first half of 2009, have disappointed since then. "For the U.S. to have a positive outlook, we have to have an export-led economy," he says. "We can't expect [domestic] construction to come back any time soon."

Disinflation PeriodStrictly speaking, we're in a period of disinflation, defined by a decline in the rate of inflation, says Joseph Trevisani, chief market analyst at FX Solutions, a currency brokerage in Saddle River, N.J. Historically, prices were relatively stable for long periods and a moderate level of inflation is a modern development, he says. Deflation, a drop in prices over a certain span of time, signals "a damaged or seriously problematic economy," he says. Disinflation increases the possibility of actual deflation occurring since any rise or fall in prices has to be seen on a continuum, Trevisani adds.

While some of the optimism about growth in the U.S. economy is justified and business conditions have improved over the past year, there isn't sufficient evidence yet to suggest the economy will be booming a few years from now, says Bosworth at Brookings. "Unemployment will be a severe overhang for prices in the U.S.," he says. "We may have some pass-through in energy prices [that boosts consumer prices generally], but I can't see the labor market righting itself in the near future." Bosworth sees no sign of pricing power in either the labor or the product markets. U.S. companies have been able to maintain high profit margins due to increased productivity and cost-cutting, not higher prices, he says.

Construction ShortageA dearth of new construction projects is preventing manufacturers from regaining any pricing power, says David Gordon, a principal at Channel Marketing Group, a marketing consulting firm that advises manufacturers, distributors, and industry associations. With so much slack in the construction industry, distributors are going after the few scraps of business they see and are so focused on capturing market share that they're willing to give up pricing power, he says.

The plumbing, building materials, and electrical supply companies he works with aren't even passing through higher fuel and other commodity costs to their customers, he adds. David Huether, chief economist for the National Association of Manufacturers, cites diminished pricing power in sectors related to housing—nonmetallic minerals such as cement, bricks, and glass, as well as furniture makers. But food and chemical manufacturers, which together make up more than 27% of the manufacturing sector, have been able to raise prices over the past year.

Food prices are up 2%, and that's only partly due to the pass-through of higher energy costs that have boosted transportation expenses for manufacturers, he says. Energy cost increases are also contributing to the 4% year-over-year rise in margins for merchant wholesalers, the middlemen between food producers and retailers. Prices for chemicals—including pharmaceuticals and paints—have risen 3% since April 2009. Because many chemicals are feed products used to make other products like plastics, "chemicals are typically a good predictor of demand going forward for final products," says Huether. Apparel prices, however, have dropped dramatically over the last several months, according to Charles McMillion, chief economist at MBG Information Services in Washington.

Money ConstraintsThe decline in the money supply—one of the few factors that countered rather than contributed to the 1.4% uptick in the March Leading Economic Indicators data released on Apr. 19—is another red flag for deflation. There's been a remarkable collapse in bank lending since April 2009, mostly due to banks' efforts to conserve cash to pay back money received under the U.S. government's Troubled Asset Relief Program, according to Michael Englund, chief economist at Action Economics. That's one reason for the slow pace of economic growth, he says.

There's also significantly less demand for loans at the terms banks are willing to extend right now, says Jefferson Harralson, a bank analyst at Keefe Bruyette & Woods. No loans are being made in large categories such as construction, land, and commercial real estate, and he doesn't believe that banks that have repaid TARP money are more willing to lend than banks that still owe the government money. What's so unusual about the current situation is the enormous amount of liquidity that's available but not circulating, says Trevisani. It isn't encouraging the kind of economic activity that typically would lead to higher inflation.

The 1.6% month-over-month increase in March retail sales and the general strength of consumer spending hardly support concerns over potential deflation. But spending is up at the expense of household savings, which have dropped much more quickly than most people expected, from between 6% and 7% of household income to 3.1% in February.

McMillion at MBG Information Services expects the March savings rate, which hasn't been released yet, to fall to nearly 2%. He says he doubts that consumers will "be able to keep up with anything remotely like the spending we've had." Had the savings rate stayed in the 6% to 7% range, prices would have come under more pressure than they are facing right now, says Trevisani. But the extension of unemployment insurance and other forms of government intervention have also made it easier for people who would normally be pinching pennies to continue to spend, he adds.

Tax BurdenThe prospect of new taxes threatens to weigh on consumer spending in the future, particularly if the economic recovery fails to boost job growth. The Bush Administration's tax cuts expire at the end of 2010 and the health-care reform bill contains new taxes that take effect in 2013. Congress is also weighing the possibility of a value-added tax to lower the federal deficit, and legislation aimed at reducing carbon emissions may add to consumers' tax burden in the future.

"The taxes that are coming don't seem to be affecting [consumer] spending a great deal yet, but it seems to be reflected in consumer sentiment numbers," which are falling, says Trevisani. As long as hikes in wages and the prices of most consumer products are not viable for businesses, there remains a basic deflationary risk, says Bosworth. Even if you're inclined to believe the risks of inflation and deflation are balanced, were events to favor the deflation side, the Fed could do relatively little to fix it. The fed funds rate is already at zero, which leaves hardly any room to increase the money supply, and it wouldn't be productive to offer more stimulus money that would drive the federal deficit above 10% of GDP, he warns.

That tells him that inflation is actually a smaller risk than deflation: If it does materialize, it would be comparatively easy for the Fed to correct by raising interest rates and using other proven measures to slow activity in a booming economy. "There's no reason to fear that." The specter of a stagnant economy for an extended time—like the malaise that has plagued Japan for the past two decades—is far scarier. "[U.S.] policymakers are praying that the economic growth will be sustainable and are not willing to choke it off," says Bosworth. The Fed will likely wait to raise interest rates, but it would make sense to keep unwinding "the extraordinary monetary measures" implemented over the last two years.

Senate Democratic leaders plan to seek a key procedural vote on Thursday on financial reform legislation and are targeting a final vote next Monday, a senior Democratic aide said on Wednesday. At the same time, Democratic leaders are awaiting the outcome of continued negotiations over the bill toward a possible bipartisan compromise, said the senior aide and other Senate staffers involved in the closed-door talks.

As Democrats press what they see as a political advantage on a contentious issue, Senator Christopher Dodd in remarks on the Senate floor said that the reform bill he authored would come to the Senate floor "in a matter of hours." "My hope is our colleagues will allow us to get to this debate," Dodd said, summarizing the main provisions of the legislation that he said "we'll present here in a matter of hours to our colleagues in this chamber."

Financial regulation reform has taken center stage in Congress as Democrats are still negotiating with Republicans over a potential bipartisan deal. The legislation under discussion would impose the sharpest regulatory crackdown on banks and capital markets since the Great Depression.

The Senate Agriculture Committee approved a bill on Wednesday to impose new rules on the $450 trillion over-the-counter derivatives market. It was harsher than language backed last month by the Senate Banking Committee.The agriculture panel's bill picked up one Republican vote in support, while the milder banking panel version garnered none at all, winning committee approval on a party-line vote. The main vehicle for reform will be the banking committee's bill, according to Senate aides.

Democrats plan to call for a vote to try to block a Republican filibuster that could prevent formal debate from starting on the bill, under development for months now. Sixty votes are needed to invoke "cloture," blocking a filibuster. Democrats control 59 Senate votes and would need at least one Republican vote for cloture to proceed.

Both Parties Have Held Dozens of Fund-Raisers on Wall Street While Fashioning New Regulations for Financial Markets

Lawmakers in both parties have been raising hundreds of thousands of dollars in campaign contributions from Wall Street in recent months, offering the industry access to members of Congress who are working on legislation that could alter the rules for American finance. Democrats and Republicans have held at least three dozen fund-raising events with Wall Street bankers and lobbyists for companies such as Goldman Sachs Group Inc., J.P. Morgan Chase & Co. and Morgan Stanley.

Invitations to some of the fund-raisers highlight access to lawmakers. "This unique program provides benefits designed to give you quality time with Republican policy makers through small gatherings," wrote Sen. John Cornyn (R., Texas) to Wall Street executives in an invitation to join a business council of the National Republican Senatorial Committee, which he heads. The donation requested: $10,000. The group held discussions with GOP senators in February and March.

Democrats raising money from the financial-services industry include Senate Majority Leader Harry Reid of Nevada, who went to New York this year for a fund-raising event with several executives from Goldman Sachs. In January, Sen. Blanche Lincoln (D., Ark.) raised campaign funds from J.P. Morgan and other Wall Street firms. Mrs. Lincoln leads the Senate Agriculture Committee, in charge of writing federal rules for financial derivatives. J.P. Morgan and other major Wall Street firms oppose Mrs. Lincoln's proposal but say they would support new regulations.

Raising campaign cash on Wall Street is a year-round activity for lawmakers: Companies and executives in the financial sector are the second-leading source of campaign money for all candidates for Congress, behind the health-care industry. Democrats have long received the lion's share of campaign donations from Wall Street. President Barack Obama received nearly $15 million in the 2008 presidential campaign from the securities and investment industry, according to the Center for Responsive Politics. Republicans have noted that Goldman Sachs employees gave Mr. Obama nearly $1 million during the campaign, making the company his second-largest source of donations. Mr. Obama hasn't said if he would return the Goldman donations in the wake of recent allegations against the company.

Of the $34 million given by the securities and investment industry in the 2010 election cycle, 62% has gone to Democrats and 37% to Republicans, according to the nonpartisan Center for Responsive Politics. This year, major Wall Street firms have begun giving a larger share of their donations to Republicans. In January and February, political-action committees run by Citigroup Inc., Goldman Sachs, J.P. Morgan and Morgan Stanley donated twice as much money to Republicans than Democrats, a shift from 2009. Some outsiders are criticizing the timing of the recent fund-raising events as Congress weighs financial-services legislation.

"It gives at the very least the appearance of influence—or, at worst, actual influence over legislation that affects the general public," said John Taylor, chief executive of the National Community Reinvestment Coalition, a consumer advocacy group. The Republican senatorial committee has "worked hard to expand our donor base in all parts of the country, and that includes New York City,'' said a spokesman for Mr. Cornyn and the NRSC. A spokesman for Mr. Reid said the senator was "leading the effort to hold Wall Street accountable." Mrs. Lincoln's spokeswoman said the senator's derivatives proposal was tough and "shows that no concessions were made to Wall Street banks."

The financial-services legislation seeks to create greater government oversight of the industry and to regulate some practices implicated in the recent financial collapse. Democrats in the House passed a version of the legislation last year over Republican opposition. In the Senate, Democrats overcame Republican resistance to pass the bill through the Banking Committee earlier this year. The bill may come to the Senate floor this week or next. Sen. Charles Schumer (D., N.Y.), a member of the Banking Committee, raised money for the Senate Democrats' campaign arm at an April event sponsored by John Paulson, the New York hedge manager at the center of the government's fraud case against Goldman Sachs.

Mr. Schumer is "one of the few members of Congress who has consistently supported the hedge-fund industry," said Mr. Paulson in a letter inviting other Wall Street executives to the event. Neither Mr. Paulson nor his firm has been charged with wrongdoing. Sen. Richard Shelby of Alabama, the top Republican on the Banking Committee, has attended at least a half-dozen fund-raisers in the last few months with lobbyists and executives, according to invitations viewed by The Wall Street Journal.

On March 11, Mr. Shelby was scheduled to attend a $1,000-a-person breakfast fund-raiser at the offices of Washington lobbying firm K&L Gates LLP, the Financial Accounting Foundation and Pitney Bowes, which is lobbying aspects of the financial overhaul. A few hours later, he was to attend a $1,000-a-person lunch at the private 116 Club on Capitol Hill with a slate of lobbyists for other Wall Street firms. Mr. Shelby's campaign-finance reports suggest that fund-raising on Wall Street spiked as the legislative activity on Capitol Hill increased. In February, Mr. Shelby received $55,000 from Wall Street political action committees and executives, according to his most recent campaign report.

In March, when Senate negotiations intensified on the financial-services bill, Mr. Shelby received $200,000 in Wall Street donations, including $50,000 from employees of J.P. Morgan and Morgan Stanley. "Those who contribute to the senator's campaign do so in full support of the senator's philosophy, and not the other way around," a spokesman for Mr. Shelby said.

Senate Minority Leader Mitch McConnell (R., Ky.) was in New York recently for meetings and fund-raisers with executives from securities firms, hedge funds and insurance companies. Campaign-finance records show that Mr. McConnell collected a total of $800,000 for the Republican senatorial committee. Some lawmakers have abandoned efforts at fund-raising that they said crossed a line. A consultant for Sen. Bob Corker, the Tennessee Republican who has sought to broker a compromise with Democrats on the bill, sent an email in March to financial executives and lobbyists.

"We are hoping for $10,000 for meal events or $5,000 for small meetings," read the email. "Let me know as soon as possible if you can assist us in filling our calendar." Mr. Corker's chief of staff, Todd Womack, said that the senator ultimately didn't raise money through those events, as the email mistakenly left the impression that a payment was required to gain access to the senator. In a statement, Mr. Womack said: "Sen. Corker has said the email was grotesque and that he would not attend any events organized as a result."

Assessing the battle to overhaul the nation’s financial regulations recently, Jamie Dimon, the chief executive of JPMorgan Chase, left no doubt about the consequences if Congress cracked down on his bank’s immense business in derivatives. "It will be negative," he said. "Depending on the real detail, it could be $700 million or a couple billion dollars." With so much money at stake, it is not surprising that more than 1,500 lobbyists, executives, bankers and others have made their way to the Senate committee that on Wednesday will take up legislation to rein in derivatives, the complex securities at the heart of the financial crisis, the billion-dollar bank bailouts and the fraud case filed last week against Goldman Sachs.

The forum for all this attention is not the usual banking and financial services committees, but rather the Senate Agriculture Committee, a group more accustomed to dealing with farm subsidies and national forest boundaries than with the more obscure corners of Wall Street. A main weapon being wielded to fight the battle, of course, is money. Agriculture Committee members have received $22.8 million in this election cycle from people and organizations affiliated with financial, insurance and real estate companies — two and a half times what they received from agricultural donors, according to the Center for Responsive Politics.

Much of that lobbying has centered on Senator Blanche Lincoln, the Arkansas Democrat who is the committee’s chairwoman and who last week introduced the bill that would prevent banks from trading derivatives directly. The daughter of a sixth-generation rice farmer, she has found herself navigating a dangerous channel between Wall Street firms, which raised $60,000 at two fund-raisers for her re-election campaign so far this year, and her constituents, many of whom want a crackdown on the speculation that led to the financial crisis. Other committee members, on both sides of the aisle, also have reaped donations from people and companies in the derivatives business, including Senator Saxby Chambliss of Georgia, who is the committee’s ranking Republican member; Kent Conrad, the North Dakota Democrat; and Charles E. Grassley, the Iowa Republican.

The committee will be the main arena for the derivatives fight for reasons dating to an era when farming was more important to the nation’s economy than finance. In their simplest form, derivatives can provide financial protection on the value of an investment or commodity. For example, by putting up a relatively small amount of money, a farmer could buy a derivative known as a forward or futures contract that would guarantee a set price for crops and thereby guard against ruinous price swings between planting and harvest.

But the most esoteric derivatives — which also are the most profitable for banks to create and trade — have little economic purpose other than to let investors place financial bets, critics say. A more complex type of derivative helped to inflate the housing bubble in recent years, as Wall Street repackaged high-risk mortgages into securities that speculators could use to bet on the direction of the housing market. Financial institutions earned millions of dollars in fees for creating the securities. But many of the derivatives became worthless when foreclosures skyrocketed, leading to billions of dollars of losses — and taxpayer bailouts — at the banks and insurance companies that owned them.

Now, these obscure and largely unregulated securities — more than $600 trillion of which are tucked into investors’ portfolios, according to the Treasury Department — are at the center of the fight over financial reform led by the Obama administration. "The best that we can do for the American people is to put in place rules that will prevent firms from taking this risk again, make sure we protect the taxpayer, bring derivatives out of the dark — that’s what we can do, " said Timothy F. Geithner, the Treasury secretary.

The lobbying is not just coming from Wall Street. Manufacturers, airlines and other industries, which use derivatives to control their business and foreign currency costs, worry that an important means of protecting their assets could be curtailed by Mrs. Lincoln’s bill. "I think a lot of members of Congress are just getting up to speed on how these markets work," said Paul Cicio, who is president of the Industrial Energy Consumers of America, which represents an array of industries like fertilizers and chemicals.

He said he worried that the lobbying prowess and financial resources of Wall Street firms, even when operating in the unusual environs of the agriculture committee, had the potential to outmuscle their opponents, which want greater regulation. "Of course I’m going to be concerned, because they are big-money companies," and derivatives make up substantial portions of their profit margins, he said. "But this is incredibly important, and it’s important to get it right."

On Friday, Mrs. Lincoln introduced a derivatives bill that seemed intended to show that she could be hard-nosed with Wall Street yet accommodating to Arkansas constituents, ranging from Wal-Mart to small community banks, which have a big interest in the derivative fight. Small-town bankers in Arkansas and elsewhere want to regulate derivative speculation because they believe widespread betting on home mortgages led to bank failures and pushed up the cost of federal deposit insurance for all banks.

The derivatives bill, which is expected to be folded into the sweeping overhaul of the nation’s banking system, would also require most derivatives trades to be routed through a third party, known as a clearing agent. That would provide each of the parties a guarantee that they would be paid if the other party defaulted or went out of business. The bill would also require most derivatives to be traded on an open exchange.

Currently, the only way to trade many derivatives is to call up various dealers and ask for the price at which they are willing to buy or sell. The securities dealer profits from the difference between the prices at which it buys from one party and sells to another. Investors rarely, if ever, see details on the other side of the trade. Wall Street has signaled that it can live with a clearinghouse approach, but it is strongly opposed to exchange trading of derivatives, which would introduce price competition and lower the profits.

Wall Street bankers were stunned by the most aggressive portion of Ms. Lincoln’s bill, one that is opposed even by the Obama administration. That proposal would essentially ban banks from being dealers in swaps or other derivatives by taking away their access to federal deposit insurance and their ability to borrow from the Federal Reserve if they kept those businesses. Mrs. Lincoln, who is facing a tough primary challenge in May to get to the general election in November, said in an interview that she was not sure why the administration did not fully agree with her derivatives approach. "The people of Arkansas never again want to have to foot the bill for what happens on Wall Street," she said. "If banks want to be in that kind of risky business, they should have to separate it off in a way that lowers the systemic risk."

CHAIRMAN KANJORSKI: And now we’ll hear from Mr. William K. Black, Associate Professor of Economics and Law, the University of Missouri, Kansas City School of Law. Mr. Black.

BILL BLACK: Members of the Committee, thank you. You asked earlier for a stern regulator, you have one now in front of you. And we need to be blunt. You haven’t heard much bluntness in hours of testimony. We stopped a nonprime crisis before it became a crisis in 1991 by supervisory actions. We did it so effectively that people forgot that it even existed, even though it caused several hundred million dollars of losses — but none to the taxpayer. We did it by preemptive litigation, and by supervision. We broke a raging epidemic of accounting control fraud without new legislation in the period of 1984 through 1986. Legislation would’ve been helpful, we sought legislation, but we didn’t get it. And we were able to stop that because we didn’t simply consider business as usual. Lehman’s failure is a story in large part of fraud. And it is fraud that begins at the absolute latest in 2001, and that is with their subprime and liars’ loan operations. Lehman was the leading purveyor of liars’ loans in the world. For most of this decade, studies of liars’ loans show incidence of fraud of 90%. Lehmans sold this to the world, with reps and warranties that there were no such frauds. If you want to know why we have a global crisis, in large part it is before you. But it hasn’t been discussed today, amazingly.

Financial institution leaders are not engaged in risk when they engage in liars’ loans — liars’ loans will cause a failure. They lose money. The only way to make money is to deceive others by selling bad paper, and that will eventually lead to liability and failure as well. When people cheat you cannot as a regulator continue business as usual. They go into a different category and you must act completely differently as a regulator. What we’ve gotten instead are sad excuses. The SEC: we’re told they’re only 24 people in their comprehensive program. Who decided how many people there would be in their comprehensive program? Who decided the staffing? The SEC did. To say that we only had 24 people is not to create an excuse — it’s to give an admission of criminal negligence. Except it’s not criminal, because you’re a federal employee.

In the context of the FDIC, Secretary Geithner testified today that this pushed the financial system to the brink of collapse But Chairman Bernanke testified we sent two people to be on site at Lehman. We sent fifty credit people to the largest savings and loan in America. It had 30 billion in assets. We had a whole lot less staff than the Fed does. We forced out the CEO. We replaced the CEO. We did that not through regulation but because of our leverage as creditors. Now I ask you, who had more leverage as creditors in 2008? The Fed, as compared to the Federal Home Loan Bank of San Francisco, 19 years earlier? Incomprehensible greater leverage in the Fed, and it simply was not used.

Let’s start with the repos. We have known since the Enron in 2001 that this is a common scam, in which every major bank that was approached by Enron agreed to help them deceive creditors and investors by doing these kind of transactions. And so what happened? There was a proposal in 2004 to stop it. And the regulatory heads — there was an interagency effort — killed it. They came out with something pathetic in 2006, and stalled its implication until 2007, but it ’s meaningless. We have known for decades that these are frauds. We have known for a decade how to stop them. All of the major regulatory agencies were complicit in that statement, in destroying it. We have a self-fulfilling policy of regulatory failure because of the leadership in this era.

We have the Fed, the Federal Reserve Bank of New York, finding that this is three card monty. Well what would you do, as a regulator, if you knew that one of the largest enterprises in the world, when the nation is on the brink of economic collapse, is engaged in fraud, three card monty? Would you continue business as usual? That’s what was done. Oh they met a lot — they say "we only had a nuclear stick." Sounds like a pretty good stick to use, if you’re on the brink of collapse of the system. But that’s not what the Fed has to do. The Fed is a central bank. Central banks for centuries have gotten rid of the heads of financial institutions.

The Bank of England does it with a luncheon. The board of directors are invited. They don’t say "no." They are sat down. The head of the Bank of England says "we have lost confidence in the head of your enterprise. We believe Mr. Jones would be an effective replacement. And by 4 o’clock that day, Mr. Jones is running the place. And he has a mandate to clean up all the problems. Instead, every day that Lehman remained under its leadership, the exposure of the American people to loss grew by hundreds of millions of dollars on average. Auroroa was pumping out up to 300 billion dollars a month in liars’ loans. Losses on those are running roughly 50% to 85 cents on the dollar. It is critical not to do business as usual, to change.

We’ve also heard from Secretary Geithner and Chairman Bernanke — we couldn’t deal with these lenders because we had no authority over them. The Fed had unique authority since 1994 under HOEPA to regulate all mortgage lenders. It finally used it in 2008. They could’ve stopped Aurora. They could’ve stopped the subprime unit of Lehman that was really a liar’s loan place as well as time went by. (Kanjorski bangs the gavel) Thank you very much.

In yet another sign that the country can't rely solely on regulators to police the financial system, Treasury Secretary Timothy Geithner told Congress Tuesday that the system needs "clear rules" that impose "unambiguous limits" on financial firms. But Geithner's desire is undercut by the bill under consideration in the Senate. The legislation, proposed by Senate Banking Committee Chairman Christopher Dodd, doesn't specify clear rules or unambiguous limits. Specifically, it doesn't set firm rules on how much cash firms are required to keep on hand; the amount of capital they need in order to back up their loans and other assets; or limits on leverage. Rather, it leaves those issues up to regulators at the Federal Reserve.

"We cannot design a system that relies on the wisdom of regulators to act preemptively with perfect foresight," Geithner told the House Financial Services Committee. "To come in and preemptively diffuse pockets of risk and leverage in the system. You can't build a system that... requires that level of preemptive exercise of perfect foresight. It is not possible." Later, Geithner told Rep. Ed Royce (R-Calif.): "The only way I'm aware of to design a more stable system is to use capital requirements... to set and enforce constraints in leverage on institutions that could pose catastrophic risks to the financial system."

The debate over setting firm rules versus giving regulators more authority and discretion is an important one: regulators and policymakers now argue that financial regulators didn't have the necessary authority to effectively police large, interconnected Wall Street firms like Goldman Sachs and Bear Stearns, for example, or to orderly wind down failing firms like Lehman Brothers and AIG. Had they been armed with those powers back then, things might have turned out different, say the Obama administration and its backers.

Others dismiss that argument by claiming that regulators had the authority back then -- they just chose not to use it. The U.S. Securities and Exchange Commission, for example, had full oversight over Lehman Brothers yet chose not to exercise it, according to Congressional testimony delivered Tuesday by the examiner in the Lehman Brothers bankruptcy, Anton R. Valukas. The Fed had full access to Lehman's books for months before it failed, yet steadfastly stood by while the firm descended into bankruptcy.

In AIG's case, the Office of Thrift Supervision had full regulatory authority over the firm's derivatives dealings. Yet that agency, too, chose not to exercise its full powers. The problem with the crisis and the regulatory failings that preceded it wasn't a lack of regulation or a lack of regulatory authority, critics say -- it was the refusal to use it. Yet beginning on page 91 of the 1,408-page bill, the language in Dodd's bill is clear: The Fed's Board of Governors "shall" establish rules that "are more stringent" on systemically-important firms when it comes to capital requirements, leverage limits and liquidity requirements (the three things highlighted above). But when it comes to specifics or how stringent those rules will be, that is entirely up to the Fed.

Even the oversight council that's supposed to watch over the system doesn't have full authority to crack down on Wall Street. Rather, it "may" institute rules on capital, leverage and liquidity. It also "may" not. To Geithner, that appears to be enough. "In the bill that Senator Dodd has proposed in the Senate, he takes an approach which does impose actual limits and would require the Federal Reserve, if passed, to design regulations that would apply those limits," Geithner said. "So, it includes your broad grant of authority but accompanies that with an explicit requirement that clear limits be put in place," he told Rep. Paul Kanjorski (D-PA). The bill doesn't specify the kind of limits that will be put in place. it just promises to be "more stringent."

In a January speech, Federal Reserve Chairman Ben Bernanke said that regulators -- including those at the Fed -- were to blame for the housing bubble and subsequent financial crisis. "The crisis revealed not only weaknesses in regulators' oversight of financial institutions, but also, more fundamentally, important gaps in the architecture of financial regulation around the world," Bernanke said in January. But regulators always run the risk of being shoddy, especially when it comes to policing financial firms. "It is the habit of regulatory agencies to get captured by the industries that they are meant to be regulating," said Raj Date, chairman and executive director of the Cambridge Winter Center, a non-profit, non-partisan think tank focused on U.S. financial institutions. This happens most often with the bank regulators, Date said.

That's why, Date argues, the financial system needs "more bright lines" in legislation regarding what banks can and cannot do, and how much cash and capital they're required to have, for example. In an interview with the Huffington Post, Federal Reserve Bank of Kansas City President Thomas M. Hoenig said he prefers for these rules to be set in law, rather than having it be left to regulators. So does former Fed chairman Paul Volcker, who told HuffPost that there's too much pressure on regulators and that they'd be too scared to act.

In an April 14 letter to Senate leadership, three dozen top economists, Wall Street veterans and former federal regulators called for specific minimum capital levels for banks to be enacted into law. "The best strategy is to force the financial system to operate with more transparency, with clear rules that set unambiguous limits on leverage and risk, so that taxpayers never have to come in and protect the economy by saving firms from their mistakes," Geithner said Tuesday. To Date, that's Geithner recognizing "that just hoping for the magical superhero to appear in regulators' clothing forevermore is neither a great nor realistic aspiration."

And while Date thinks the Dodd bill is "certainly better than where we are today," it still doesn't go far enough in calling for the kind of fundamental reform some say is needed in the wake of the worst financial crisis and economic downturn since the Great Depression. Rather than the Senate enacting tougher rules, it's punting the issue to regulators, all of whom, at one point or another over the last two years, acknowledged mistakes, lapses in judgment, and laxity in regulating the financial industry.

"Three years after mortgage credit began to fall apart in the U.S., it ought to be that Congress should be in a position to draw a bright line" regarding rules governing the financial system, Date said. "I just don't see why one can't do that."

One question has vexed the Obama administration and Congress since the start of the financial crisis: how to prevent big bank bailouts. In the last year and a half, the largest financial institutions have only grown bigger, mainly as a result of government-brokered mergers. They now enjoy borrowing at significantly lower rates than their smaller competitors, a result of the bond markets’ implicit assumption that the giant banks are "too big to fail."

In the sweeping legislation before the Senate, there is no attempt to break up big banks as a means of creating a less risky financial system. Treasury Department and Federal Reserve officials have rejected calls for doing so, saying bank size alone is not the most important threat. Instead, the bill directs regulators to compel the largest banks to hold more capital as a cushion against losses. It sets up a procedure intended to allow big banks to fail, with the cost borne not by taxpayers but by the biggest financial institutions.

As the debate over the regulatory overhaul heated up this week, a populist minority in both Congress and the Fed requested a revisit to the size issue. They would like to go beyond a provision in the bill, suggested by Paul A. Volcker, the former Fed chairman, and supported by President Obama, that would seek to keep banks from growing any larger but not force any to shrink. "By splitting up these megabanks, we by definition will make them smaller, safer and more manageable," Senator Edward E. Kaufman Jr., Democrat of Delaware, said in a speech Tuesday.

The president of the Federal Reserve Bank of Dallas, Richard W. Fisher, broke ranks with most of his colleagues within the central bank last week, declaring, "The disagreeable but sound thing to do regarding institutions that are too big to fail is to dismantle them over time into institutions that can be prudently managed and regulated across borders." There also has been concern about the size of banks from Republicans who believe in free-market principles. Several senators from the South and West — Richard C. Shelby of Alabama, Johnny Isakson of Georgia, John Cornyn of Texas and John McCain of Arizona — have expressed a desire to revisit the 1999 repeal of the Glass-Steagall Act, the Depression-era law that separated commercial and investment banking.

Alan Greenspan, the former Fed chairman, has entertained the idea of splitting up the banks but has stopped short of advocating it. "If they’re too big to fail, they’re too big," he said in an October speech. He added: "In 1911, we broke up Standard Oil. So what happened? The individual parts became more valuable than the whole. Maybe that’s what we need."

In January, the White House embraced a proposal by Mr. Volcker that would ban banks that take customer deposits from running their own proprietary trading operations, or making market bets with their own money. It would also limit the share of all financial liabilities that any one institution can hold — besides deposits — but it would be up to regulators to set the limit. A federal law enacted in 1994 already addresses size by restricting any bank from holding more than 10 percent of the nation’s deposits, although several of the largest banks have been granted waivers from that requirement or used loopholes to evade its intent.

The Volcker proposal resembled an amendment by Representative Paul E. Kanjorski, Democrat of Pennsylvania, that would let regulators dismantle financial companies so large, interconnected or risky that their failure would jeopardize the entire system. The amendment was part of a regulatory overhaul that the House adopted in December, largely along party lines, and is also in the Senate version in a modified form. At a hearing on Tuesday about the bankruptcy of Lehman Brothers, which caused credit markets to seize up in September 2008, the Fed chairman, Ben S. Bernanke, reiterated that his preference was to limit the risky behavior of banks rather than break them up.

"Through capital, through restrictions in activities, through liquidity requirements, through executive compensation, through a whole variety of mechanisms, it’s important that we limit excessive risk-taking, particularly when the losses are effectively borne by the taxpayer," Mr. Bernanke said. But when Mr. Kanjorski pressed him on whether regulators should be allowed to break up big banks, he replied, "It’s something that would be, on the whole, constructive." Representative Brad Sherman, Democrat of California, added: "We should go further and not just allow, but require, regulators to break up firms that have reached a certain size."

What is not in doubt is that the crisis increased the size and importance of the six largest banks: Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs and Morgan Stanley. During the crisis, Bank of America swallowed Merrill Lynch, JPMorgan Chase bought Bear Stearns and Wells Fargo acquired Wachovia. Goldman and Morgan converted to bank holding companies to gain access to lending from the Fed’s discount window. In 1995, the assets of the six largest banks totaled 17 percent of the nation’s gross domestic product. Now they have assets amounting to 63 percent of G.D.P. Measured another way, the share of all banking industry assets held by the top 10 banks rose to 58 percent last year, from 44 percent in 2000 and 24 percent in 1990.

Gary H. Stern, the co-author of "Too Big to Fail: The Hazards of Bank Bailouts," said policy makers largely ignored the warnings contained in the title when the Brookings Institution published the book in 2004. Mr. Stern, who retired last year as president of the Minneapolis Fed, is lukewarm about the bill. "It tries to address the problem but it’s half a loaf at best," he said. "It doesn’t address the incentives that gave rise to the problems in the first place." In Mr. Stern’s view, ending "Too Big to Fail" should subject uninsured creditors — bondholders — to losses if the bank fails. Without that fear, he said, unsecured creditors will not exert discipline on the banks by monitoring their risk-taking and pricing their loans appropriately. Mr. Stern said the bill in the Senate is vague about how such creditors would be treated if the government were to seize and dismantle a failing bank.

Simon Johnson, an M.I.T. professor, has been leading the intellectual charge to break up banks. In his book "13 Bankers," he urged that no financial institution be permitted to control more than 4 percent of G.D.P. and no investment bank more than 2 percent. All six of the big financial institutions exceed those limits. Forbidding taxpayer bailouts, as the Senate bill proposes, is worth little more than the paper it is on, Mr. Johnson argues. "When push comes to shove, will the government save these guys?" he asked. "I don’t know anybody who doesn’t think they’d save Goldman if Goldman were to suddenly run into trouble."

The special inspector general for the government's bailout program said he would probe whether securities sold by Goldman Sachs Group Inc led to losses at AIG and if the American taxpayer was a victim of fraud. Goldman Sachs was charged last week with fraud by the U.S. Securities and Exchange Commission over its marketing of a subprime mortgage product. The SEC's charges concern Abacus, a synthetic collateralized debt obligation that hinged on the performance of subprime residential mortgage-backed securities, and which the regulator said Goldman structured and marketed.

According to the SEC, Goldman did not tell investors "vital information" about Abacus, including that Paulson & Co was involved in choosing which securities would be part of the portfolio Paulson was separately betting against. There are seven deals similar to Abacus for which AIG wrote credit default swaps, according to Neil Barofsky, the special inspector general for the Troubled Asset Relief Program. American International Group Inc, or AIG, is the insurance behemoth largely owned by U.S. taxpayers after its government bailout last year.

Barofsky said he is in touch with the SEC and will possibly coordinate with the Department of Justice "to see if there are cases of fraud and if AIG and as a result, the American taxpayers, were victims of similar types of fraud." Barofsky made the comments in response to questions from the ranking Republican on the Senate Finance Committee, Charles Grassley, at a hearing examining the TARP.Separately, but also in response to questions, Barofsky said he is considering a broader audit of the role of BlackRock Inc in TARP.

"We are doing a number of audits that touch on Blackrock's role. And it is an extensive role throughout this financial crisis," Barofsky said. For example, current audits, including one on Citigroup Inc's asset guarantee program, touch on Blackrock, he said. "We are considering doing a more overarching audit report on their role throughout the financial crisis."

The government so far has spent $3 trillion to stem the financial crisis, said Neil Barofsky, the Special Inspector General for the TARP. "It's about $3 trillion -- all in, with all the various programs and support [for] the financial industry," Barofsky told lawmakers participating in a Senate Finance hearing on the bank tax. The figure will be updated in Treasury's quarterly report due out in July and will include all payments made by all government entities.

(The following is an interview with Fred Hickey, author of the widely-read High-Tech Strategist newsletter)

A few weeks ago, I asked Fred Hickey what he would do as chairman of the Federal Reserve. In the remainder of our interview, I asked Fred whether we can avoid recessions in a business cycle, what will happen to the US Dollar, how our creditors are behaving, and what advice he can offer given the new economic environment.

Damien Hoffman: Fred, can we create a perpetual business cycle where we don’t get recessions?Fred: No. I have a quotation on my board here that says, "The final outcome of the curve expansion is general impoverishment." That means if we continue down this path the outlook, unfortunately, is general impoverishment for the country. I hope that’s not how it’s going to play out. But I’m not particularly optimistic with the current leadership that we have in government today. At some point the dollar is going to break down — really break down. Right now there’s still a rush to safety from the worry about Europe. But I don’t know why they’re so worried about Europe when we’re the ones with the trillions of dollars of deficits.

Damien: It’s an ironic flight to safety. It’s almost a cosmic comedy.Fred: It’s just a Pavlovian reaction. However, at some point that won’t be the reaction and the dollar will get crushed. Eventually there will be some recognition that this country is broke. No one seems to be talking about this, but in a recent US Treasury foreign holdings report I saw a flat line where the mainland Chinese were not buying our treasuries anymore. Their position was holding; meaning, they were buying just enough to offset the maturing bonds. Now we’re seeing outright declines. This has gone on for several months and now it’s an outright decline.

Damien: What about the Russians?Fred: The Russians are also reducing their positions. They reduced $10 billion in December and it’s dropped from a $140 billion almost to $118 billion over the last few months. The Russians have been out there saying they’re buying gold, Canadian bonds, and diversifying their positions. Well, here they are doing it. At some point, enough people around the world will say they don’t want to be in dollars anymore and they will get out. It looks to me that the Chinese and the Russians are getting out. The smart guys are leaving the ship and it looks to me like we’re replacing them with are our own printed money as well as hedge funds who are borrowing money and buying treasuries. This is a very bad group to have. Those are not long term holders. That could reverse very quickly. If that happens you can have a dollar collapse.

Damien: So is gold the hard currency which will continue to win?Fred: I never lose sleep with my big gold position, but I do lose sleep when I have a big dollar position. I always see pullbacks in gold as buying opportunities because what I’ve discussed are the big forces really moving things. There are very few people on this planet that understand the big macro picture behind the movement to gold. We’re now in a 10 year bull market in gold. We ran a twenty year bear market, so it might be a twenty year bull market. We may be only halfway through. I’m not sweating $1100 gold as the top like so many others in this country. They see bubbles everywhere in gold. They never saw the bubble in real estate, never saw the bubble in stocks, never saw anything. However, all these people in the U.S. see a bubble in gold. I don’t see it. I sleep like a baby with my gold position.

Damien: Fred, given the situation our country faces, what type of advice do you give your children?Fred: That’s a hard question. First, you must be willing to work hard at anything you do. Try to find something you enjoy and you can feel good about. It helps you work hard. Save your money and don’t build up debts. I never get myself in any kind of trouble because I never had any debt. So, if I’m wrong I’m never going to get really destroyed because I don’t have leverage. Debt is a four letter word. I’m an old fashioned guy. Don’t ignore history. There are a lot of lessons to be learned that many people seem to never learn. I have my kids reading what I consider to be many of the investment classics.

Damien: That’s great advice especially keeping out of debt. If most Americans just followed that one simple principle, we’d be in a whole different position right now.Fred: If most individuals and our government.

A March survey from Pew shows just how broad the unemployment pain has been felt. When you hear of 10% unemployment, you might imagine 1/10th of Americans experiencing extreme financial stress from the recent recession.

Yet given the unemployment rate's odd methodology whereby it drops people who stop looking for work out of the data, and the fact that American households usually have more than one person, the real 'pain' number is 54% -- over half of American households felt the direct impact of job losses:

A majority now says that someone in their household has been without a job or looking for work (54%); just 39% said this in February 2009. Only a quarter reports receiving a pay raise or a better job in the past year (24%), while almost an equal number say they have been laid off or lost a job (21%).

Basically, if your household didn't experience un- or under-employment, then you are in the minority. Moreover, as shown above, fully 70% of American households experienced one of the serious financial problems above. Basically, the vast majority of American households was hit extremely hard.

The global financial system is again transfixed by sovereign debt risks. This evokes bad memories of defaults and near-defaults among emerging nations such as Argentina, Russia and Mexico. But the real issue is not whether Greece or another small country might fail. Instead, it is whether the credit standing and currency stability of the world's biggest borrower, the US, will be jeopardised by its disastrous outlook on deficits and debt.

America's fiscal picture is even worse than it looks. The non-partisan Congressional Budget Office just projected that over 10 years, cumulative deficits will reach $9,700bn and federal debt 90 per cent of gross domestic product - nearly equal to Italy's. Global capital markets are unlikely to accept that credit erosion. If they revolt, as in 1979, ugly changes in fiscal and monetary policy will be imposed on Washington. More than Afghanistan or unemployment, this is President Barack Obama's greatest vulnerability.

How bad is the outlook? The size of the federal debt will increase by nearly 250 per cent over 10 years, from $7,500bn to $20,000bn. Other than during the second world war, such a rise in indebtedness has not occurred since recordkeeping began in 1792. It is so rapid that, by 2020, the Treasury may borrow about $5,000bn per year to refinance maturing debt and raise new money; annual interest payments on those borrowings will exceed all domestic discretionary spending and rival the defence budget. Unfortunately, the healthcare bill has little positive budget impact in this period.

Why is this outlook dangerous? Because dollar interest rates would be so high as to choke private investment and global growth. It is Mr Obama's misfortune to preside over this. The severe 2009-10 fiscal decline reflects a continuation of the Bush deficits and the lower revenue and countercyclical spending triggered by the recession. His own initiatives are responsible for only 15 per cent of the deterioration. Nonetheless, it is the Obama crisis now. Now, the economy is too weak to withstand the contractionary impact of deficit reduction. Even the deficit hawks agree on that. In addition, Mr Obama has appointed a budget commission with a December deadline. Expectations for it are low and no moves can be made before 2011.

Yet, everyone already knows the big elements of a solution. The deficit/GDP ratio must be reduced by at least 2 per cent, or about $300bn in annual spending. It must include spending cuts, such as to entitlements, and new revenue. The revenues must come from higher taxes on income, capital gains and dividends or a new tax, such as a progressive value added tax. It will be political and financial factors that determine which of three budget paths America now follows. The first is the ideal. Next year, leaders adopt the necessary spending and tax changes, together with budget rules to enforce them, to reach, for example, a truly balanced budget by 2020. President Bill Clinton achieved a comparable legislative outcome in his first term. But America is more polarised today, especially over taxes.

The second possible course is the opposite: government paralysis and 10 years of fiscal erosion. Debt reaches 90 per cent of GDP. Interest rates go much higher, but the world's capital markets finance these needs without serious instability. History suggests a third outcome is the likely one: one imposed by global markets. Yes, there may be calm in currency and credit markets over the next year or two. But the chances that they would accept such a long-term fiscal slide are low.

Here, the 1979 dollar crash is instructive. The Iranian oil embargo, stagflation and a weakening dollar were roiling markets. Amid this nervousness, President Jimmy Carter submitted his budget, incorporating a larger than expected deficit. This triggered a further, panicky fall in the dollar that destabilised markets. This forced Mr Carter to resubmit a tighter budget and the Fed to raise interest rates. Both actions harmed the economy and severely injured his presidency. America's addiction to debt poses a similar threat now. To avoid an imposed and ugly solution, Mr Obama will have to invest all his political capital in a budget agreement next year. He will be advised that cutting spending and raising taxes is too risky for his 2012 re-election. But the alternative could be much worse.

The writer is chairman of Evercore Partners and was deputy US Treasury secretary under President Clinton

A healthier world economy and better financial conditions have reduced banks’ need to write down assets but sovereign debt problems may be spreading, according to the International Monetary Fund. In its twice-yearly global financial stability report, the fund reduced its estimate of the writedowns required of banks around the world to $2,300bn from an earlier estimate of $2,800bn made six months ago. A recovery in the financial markets had increased the value of their assets and made it easier to raise capital, the fund said.

But the fund said that the credit recovery would be "slow, shallow and uneven", and that sovereign debt problems in countries such as Greece had the potential to undermine the recovery. "With markets less willing to support leverage – be it on bank or sovereign balance sheets – and with liquidity being withdrawn as part of policy exits, new financial stability risks have surfaced," the report said. The rise in sovereign credit risk premiums in the early stage in the crisis had now been compounded by growing concern about the creditworthiness of countries with heavy government debt burdens. "Advanced countries have the debt levels that they had after World War Two but without a world war," said José Viñals, head of the IMF’s monetary and capital markets department.

The markets’ perception of risk in countries such as Portugal and Spain has increased recently, raising the prospect of financial contagion across southern European countries similar to the pattern previously seen in emerging market crises such as the Asian financial turmoil of 1997-98. Mr Viñals said there was little sign of serious contagion in southern Europe at the moment. Compared with Greece, Portugal and Spain had "solid fiscal institutions and little fiscal uncertainty", he said.

But the fund did underline that the global financial crisis seemed to have entered a new phase focusing on government solvency. The IMF’s report compared how sovereign risk was transmitted between European countries over different phases of the crisis. Between October 2008 and March 2009, the "systemic outbreak phase", the main sources of risk were Austria, Ireland, Italy and the Netherlands – countries that either had direct exposure to the economic turmoil in eastern Europe or general fiscal problems of their own.

In the latest, "sovereign risk phase" of the crisis, Greece, Portugal, Spain and Italy became the greatest sources of risk transfer, with investors increasingly focusing on debt problems rather than financial market problems. The IMF recently submitted an interim report to ministers from the Group of 20 countries, who meet this week in Washington, on proposals for bank levies or transactions taxes to try to discourage risky behaviour and prevent another crisis.

The sovereign debt crisis facing Europe, which started in Greece, is spreading to many other large economies in the Organization for Economic Cooperation and Development (OECD), according to New York University professor of economics Nouriel Roubini. "Public debt sustainability has exploded as a serious issue in advanced economies, most notably in the euro zone's 'PIIGS' —Portugal, Italy, Ireland, Greece and Spain—but also in many larger OECD economies, including the United States," Roubini said in a note posted on his Roubini Global Economics Web site.

As the Greek government meets with International Monetary Fund (IMF) officials in Athens, the man who called the financial crisis warns that Greece's problems will not be solved by any rescue package. "These issues within the euro zone stem primarily from a loss of competiveness, high wage growth and labor costs which outstripped productivity, undisciplined fiscal policies and, crucially, the appreciation of the euro between 2002 and 2008," he wrote.

Mirroring comments from other bears like George Soros Roubini believes the bailout will not work because it does not address those problems. "Current EU/IMF plans to rescue the worst-placed of these countries—Greece—have drawn well-placed skepticism from markets as they fail to deal with core issues of debt sustainability," he also wrote. Roubini expects the euro zone to underperform the rest of the world in 2010. He predicts the euro zone will grow by just 0.9 percent versus 2.8 percent in the US. Asia, excluding Japan, is likely to soar ahead this year with growth of 8.2 percent, while Latin American growth will top 4 percent over the course of the year, he predicts.

German finance minister Wolfgang Schauble has pleaded with his country's citizens to back a joint EU-IMF bail out for Greece worth up to €45bn (£40bn), warning that failure to act risks a financial meltdown. "We cannot allow the bankruptcy of a euro member state like Greece to turn into a second Lehman Brothers," he told Der Spiegel. "Greece's debts are all in euros, but it isn't clear who holds how much of those debts. The consequences of a national bankruptcy would be incalculable. Greece is just as systemically important as a major bank," he said.

Mr Schauble said Berlin had scant room for manoeuvre over the bail-out given a likely court challenge by German professors but promised to "abide by the constitution". German backing failed to stop spreads on 10-year Greek bonds surging to 454 basis points over German Bunds, the highest since the launch of the euro. "Investors are not going to believe in a rescue deal until every 'i' it dotted and every 't' is crossed, " said Marc Ostwald from Monument Securities. "But there is also a deeper fear that Greece could bring down the whole pack of cards."

An administrator of China's foreign exchange fund SAFE – the world's top investor – was quoted by Asia's newswire IGM-FX warning that Greece may set off a chain reaction in the eurozone, and that some states with big debts may default. "China is becoming concerned about Europe," said Simon Derrick, currency chief at the Bank of New York Mellon. "Greece is going to struggle to find anybody to buy its debt. There is no road-show in Asia, and it may pull out of its show in the US." IMF data shows that China and emerging markets have accumulated $4.8 trillion (£3.1bn) in foreign reserves. Roughly $1.7 trillion is invested in eurozone bonds. These rising powers will decide how Europe's drama unfolds.

Greece plans to raise €1.5bn in short-term notes on Tuesday . A crunch looms in mid-May with the refinancing of €8.5bn in bonds. Investors have been unsettled by growing popular hostility in Greece to austerity measures. The Adedy union has called a fresh strike on Thursday. Yiannis Panagopoulos, head of the GSEE labour group, said EU demands for a pensions shake-up are unacceptable, threatening a "social storm" if the proposals go to parliament.

Premier George Papandreou has yet to activate the EU rescue, raising EU suspicions that he is playing poker to extract better terms. Nout Wellink, Holland's member at the European Central Bank, said Greece needs to show greater "urgency". Mr Papandreou has sent mixed signals, saying Athens would make up its mind over coming weeks. "Whether the mechanism is activated or not will be judged based on what's in the interests of our country." His vague stand leaves nagging doubts that Greece may decide to opt for debt restructuring instead. This would share the pain with creditors, who might face a "haircut" of 50pc. Some City bankers are expecting a "Brady bond" solution, the 1980s formula used for Latin American debt.

Mr Papandreou said Greece "will not default" but investors will fret until he grasps the EU-IMF nettle. The political cost of doing so is rising fast. Greek polls show popular fury over the role of the IMF, long-demonised as the agent of hair-shirt Thatcherism. In reality it is unclear whether the Fund would be harsher than the EU. Brussels is already demanding a cut in the budget deficit from 12.9pc of GDP to 8.7pc, despite recession. Ken Rogoff, the IMF's ex-chief economist, said the Fund would be gentler on fiscal austerity to give the country breathing room, but might impose deep structural reforms. Eurogroup chief Jean-Claude Junker on Monday raised "the possibility of new measures" at this week's troika meeting of EU and IMF officials in Athens.

American International Group Inc., the financial firm rescued by the U.S., is the lead insurer of Goldman Sachs Group Inc.’s board against shareholder lawsuits, said a person with knowledge of the policy. AIG is among firms that sold so-called Side A directors and officers’ coverage to the New York-based bank, said the person, who declined to be identified because details of the policy are private. Goldman Sachs was sued last week by the Securities and Exchange Commission, which claimed it misled investors in 2007.

AIG, along with insurers including Chubb Corp. and XL Capital Ltd., sell so-called Side A policies. The coverage kicks in when shareholders accuse directors of wasting a company’s money through failing to perform oversight duties or if the company becomes insolvent. Goldman Sachs, the most profitable bank in Wall Street history, said today that first-quarter earnings almost doubled to $3.46 billion from a year earlier. Mark Herr, a spokesman for New York-based AIG, declined to comment. Michael DuVally, a spokesman for Goldman Sachs, didn’t immediately comment. Business Insurance reported that AIG insured Goldman Sachs’s board.

Fabrice Tourre, the Goldman Sachs banker charged with fraud by the US authorities, has been stripped of his licence to operate in the City of London. The 31-year-old French man had been registered with the Financial Services Authority to work with clients since November 2008 but today his embattled employers applied to the regulator to de-register him. The firm insisted it had taken the decision without being pressured to do so by the FSA, which has embarked on a formal investigation into the London arm of the Wall Street firm.

The FSA keeps a register of most of the people who work in the City but has different grades of authorisation. Tourre was registered to work with clients and while the FSA's website continues to show he is licensed under number FPT01004 it is understood this is likely to be updated in the coming days, possibly as soon as tomorrow. A spokeswoman for Goldman in London said: "We decided to de-register him."

However, Tourre has not been suspended by his employers. He remains on the payroll but is now on permanent leave while he and his firm fight the $1bn (£650m) fraud charges brought by the US regulator, the Securities and Exchange Commission. Goldman insists it is standing behind its employee. The revelation last Friday that the SEC was charging Goldman and Tourre with fraud following an 18-month investigation into a complex financial instrument named Abacus sparked the FSA investigation.

Goldman is strongly defending itself against the charges and insists that its own internal investigation found that Tourre had done nothing wrong. The SEC alleges that he failed to tell one of the bank's clients, financial firm ACA, that the Abacus collateralised debt obligation was being created to allow hedge fund manager John Paulson to take a big bet that the sub-prime mortgage market would collapse. The FSA would only say it was a matter for the firm.

Laggner argues that in this most recent case, Goldman left out material information when talking to potential investors about ABACUS. Now, we might find out whether or not Goldman trades against clients frequently based on material info.

In the months to come, Laggner predicts, Goldman will play hard ball and eventually settle without admitting any wrongdoing. But they'll never do it again and there will be more disclosure going forward, and more trading done on exchanges.

When more details emerge, he believes, potential Goldman clients will uncover more about Goldman's trading against and withholding valuable information from clients. In light of those new details, the stock price will go down.

"Goldman is nothing more than a glorified hedge fund taking massive bets with taxpayer subsidies," he says. "As more market participants realize this conflict of interest the business should contract rapidly."

After taxpayers rescued American International Group from the brink of collapse, the U.S. government moved to protect its investment by appointing directors and special trustees to oversee the company. Now the government's appointees, all hailing from Wall Street or the Federal Reserve, are allowing AIG to withhold key records generated during the company's decline. The documents could decode the murky circumstances leading to the second largest bailout of the financial crisis. The Huffington Post Investigative Fund has learned, in the course of inquiring into oversight of AIG, that the government's six appointed directors and trustees are resisting calls for AIG to release its internal documents and e-mails from that time.

Those calls have come from several congressmen and former financial prosecutors. They argue the documents could show how executive decisions contributed to AIG's downfall, which prompted a $182 billion government commitment. The government, meanwhile, is keeping its own secrets: Despite repeated requests, the Treasury Department hasn't divulged the criteria it used to select directors of AIG's board. Nor has Treasury disclosed how much the directors will be paid.

But former New York Gov. Eliot Spitzer, who prosecuted Wall Street fraud during his earlier role as the state's attorney general, speculated that the internal documents could only help the government determine whether AIG committed fraud in the run-up to its bailout. In any examination of corporate behavior, e-mail and internal documents are "the holy grail," Spitzer told the Investigative Fund. Such records, Spitzer noted, have been pivotal in making cases against executives of corporations such as Enron.

Responsibility for releasing the documents, Spitzer said, falls on AIG's directors and trustees. AIG has 13 directors, two of whom the Treasury Department appointed this month. Separately, the Federal Reserve Bank of New York appointed three trustees when it created the AIG Credit Facility Trust to oversee taxpayers' investment in the company. Congress also could take action. Earlier this year, Rep. Steve Israel (D-N.Y.) introduced legislation that would force AIG to release its e-mails, a move that would "get to the bottom of the AIG collapse," he said.

Ties to Wall StreetThe rise and fall of AIG can be traced to credit default swaps - insurance products the company sold to banks that had large stakes in mortgage investments. When those investments collapsed in the mortgage meltdown, AIG's insurance policies kicked in. The company, which owed billions to Goldman Sachs and others, lost $110 billion between 2008 and 2009. Taxpayers likely won't recover their bailout billions for some time. That hasn't stopped AIG from rewarding senior managers. An April 12 regulatory filing shows the company approved 2009 compensation packages worth about $30 million for its top five executives. In February, AIG received congressional scrutiny for deciding to pay employees some $100 million in bonuses.

Still, AIG has repeatedly failed to pay the government scheduled dividends on taxpayer-owned stock. As a result, the Treasury Department this month exercised its authority to appoint two directors to AIG's board. The department, led by Treasury Secretary Timothy Geithner, chose Wall Street veterans Donald H. Layton and Ronald A. Rittenmeyer. For several years while Geithner was chairman of the Federal Reserve Bank of New York, Layton was a member of the bank's international markets advisory committee. The New York Fed is AIG's main regulator. Layton, a former chairman and chief executive of E* Trade Financial, spent 29 years at JPMorgan Chase & Co., where he most recently was vice chairman.

Treasury touted Layton's executive experience when announcing his appointment in a press release on April 1. Treasury's announcement did not mention that Layton also worked for a financial industry lobbying powerhouse, the Securities Industry and Financial Markets Association, or SIFMA. The association is one of several trade groups rallying against key elements of President Obama's effort to crack down on Wall Street. From 2006 to 2008, Layton was a SIFMA senior advisor, according to published reports.

Rittenmeyer, Treasury's other pick for the board, was the chairman, president and chief executive of Electronic Data Systems, which was bought by Hewlett-Packard in 2008. He also was managing director of the Cypress Group, a private equity firm in New York. Rittenmeyer has served on the board of the national Chamber of Commerce, another industry lobbying group working to derail Wall Street reform. Layton and Rittenmeyer will be paid for serving on the board, though Treasury and AIG spokeswomen would not disclose details of their compensation. AIG's current directors receive a $150,000 retainer and $50,000 in deferred stock units annually, according to the recent regulatory filing.

It's unclear exactly what led Treasury to select Layton and Rittenmeyer for the AIG board. The government used KornFerry, an executive search firm, to aid the process. Treasury, in response to a request from the Investigative Fund, declined to disclose the search criteria. "We are confident that these appointees will make significant contributions to AIG's strategy to de-lever, de-risk and pay back taxpayers," an assistant treasury secretary, Herbert Allison, said at the time of the appointments.

"No comment"Layton and Rittenmeyer, as board members, theoretically could demand that AIG release its internal e-mail, accounting documents and financial models. The record of AIG's actions in the lead up to its bailout presumably are contained in those secret records. Both Layton and Rittenmeyer, through an AIG spokeswoman, declined to speak with the Investigative Fund or explain why they haven't compelled AIG to release the documents. If AIG's board does not disclose the documents, some believe that the three government-appointed trustees could force it to do so. The trustees can't interfere in the company's day-to-day affairs but can oust AIG's directors.

Rep. Alan Grayson (D-FL), a member of the House Financial Services Committee, has demanded that the trustees force the release of the documents. "It is beyond outrageous that this company, which taxpayers capitalized after Wall Street used it as a slush fund, hides nearly all relevant facts from its owners, the public," Grayson wrote in a March letter to the trustees. But the trustees are unwilling to meet such demands. "The trustees have no comment regarding the suggestion that AIG's board release the e-mails of the company, nor will they comment on any views they might have on that issue," Peter Bakstansky, the Trust's adviser, said in an e-mail responding to Investigative Fund inquiries in January. He confirmed Friday that the trustees have not changed their position.

The trustees each receive a $100,000 salary from AIG. Although the New York Fed considers the trustees independent, most are either current or former Federal Reserve officials. One trustee, Jill M. Considine, chairs a firm that administers hedge fund portfolios and is a former board member of the New York Fed. Another trustee, Chester B. Feldberg, was an employee of the New York Fed for 36 years. After leaving the Fed, he became chairman of Barclays Americas until 2008. Douglas L. Foshee, chief executive of the El Paso Corporation and former chief operating officer of Halliburton, is the current board chair of the Federal Reserve Bank of Dallas' Houston branch.

Peter Langerman, president and chief executive officer of the Mutual Series fund group of Franklin Templeton Investments, became a trustee after Foshee resigned in February. The Treasury Department recommended Langerman, who has donated nearly $100,000 to Democratic candidates, including Barack Obama.

AIG, the US governmentcontrolled insurer, is considering pursuing Goldman Sachs over losses incurred on $6bn (£3.9bn) of insurance deals on mortgage-backed securities similar to the one that led to fraud charges against the US bank. AIG's move over the deals that caused it a loss of about $2bn is a sign that Friday's decision by the Securities and Exchange Commission to file civil fraud charges against Goldman could spark actions from investors who lost money on mortgage-backed securities.

If AIG and others discover that their transactions had disclosure issues similar to those alleged in the SEC charges, they would be able to complain to the SEC, file a private lawsuit, or both, lawyers said.People close to the situation said that AIG was reviewing deals to insure $6bn-worth of Goldman's collateralised debt obligations in the run-up to the crisis. They added that AIG had yet to decide whether to take action. AIG and Goldman declined to comment.

Under a deal struck by AIG and Goldman last year, the bank agreed to cancel the insurance on some $3bn-worth of CDOs in exchange for keeping collateral worth about $2bn, according to people close to the situation. AIG is believed to have recorded a loss of about $2bn. The CDOs being reviewed by AIG are part of a family of securities known as Abacus. The SEC's complaint is focusing on one of the Abacus deals that is not among the securities insured by AIG.

The decision to charge Goldman was reached after a party-line vote at the SEC, with chairman Mary Schapiro and the two other Democrats voting against the two Republicans, people familiar with the ballot said.The regulators allege that Goldman hid the fact that Paulson & Co, a hedge fund that wanted to bet against the CDO, had influenced the selection of loans that went into the security. The SEC accuses Goldman of falsely representing to investors that Paulson would buy into the security. Goldman has vigorously denied all charges. Superficial resemblance between the AIG deals and the security in the SEC complaint would not be enough, lawyers said. Goldman would fight any claims on other CDOs by arguing that each security had a different structure, people familiar with the bank's thinking said.

What makes the transaction in the SEC complaint different is the allegation that Goldman actively misrepresented the role of Paulson to ACA, the independent portfolio selector.

The fraud charges against Goldman Sachs & Co. that rocked financial markets Friday are no slam dunk, as hazy evidence and strategic pitfalls could easily trip up government lawyers. Yet that hardly matters, experts say, because the allegations will kick off a new era of litigation that could entangle Goldman and other banks for years to come. The charges against Goldman relate to a complex investment tied to the performance of pools of risky mortgages. In a complaint filed Friday, the Securities and Exchange Commission alleged that Goldman marketed the package to investors without disclosing a major conflict of interest: The pools were picked by another client, a prominent hedge fund that was betting the housing bubble would burst.

Goldman said the charges are "unfounded in law and fact." In a written response to the charges, the bank said it had provided "extensive disclosure" to investors and that the largest investor had selected the portfolio — not the hedge fund client. Goldman said it lost $90 million on the deal. That doesn't contradict the SEC complaint, which says the largest investor selected the mortgage investments from a list provided by the hedge fund. And the fact that Goldman lost money has no impact on the fraud charges.

The charges will unleash a torrent of lawsuits, and likely signal that the government is prepared to file more lawsuits related to the overheated market that preceded the financial crisis, experts said. "This is just the tip of the iceberg," said James Hackney, a professor at Northeastern University School of Law. "There are a lot of folks out there in different deals who played similar roles, and once it starts building steam, plaintiffs' lawyers will figure out this is where the money is and there should be a lot of action."

Among the legal action expected in the coming months:

Class-action suits by Goldman shareholders who believe Goldman alleged misconduct made their stakes less valuable could come as early as Monday. Such suits are common when companies are accused of wrongdoing. Goldman shares fell almost 13 percent Friday as the bank lost $12.5 billion in market capitalization.

Suits by investors who believe Goldman sold them on deals that were doomed to fail. The investors in the transaction at the heart of the SEC case could sue first, followed by others who believe their losses were similar.

Possible criminal charges, if the SEC's civil case reveals evidence that meets the higher standard of "proof beyond a reasonable doubt." Experts said it's unlikely the company as a whole will face criminal charges, but evidence could emerge that would expose the Goldman executive named in the SEC complaint, 31-year-old Fabrice Tourre, to criminal prosecution.

Charges by regulators about other mortgage investments at Goldman and elsewhere. SEC enforcement chief Robert Khuzami told reporters Friday the agency is racking up evidence on other deals in the overheated market that preceded the financial crisis.

Already the case has provoked legal questions from foreign governments, according to published reports. That's because the financial crisis forced many countries to bail out banks that lost money on investments arranged by Goldman. German regulators are considering legal action against Goldman, newspaper Welt am Sonntag reported, quoting a spokesman for Chancellor Angela Merkel. The charges would be on behalf of IKB Deutsche Industriebank AG — an early victim of the financial crisis that was rescued by the state-owned KfW development bank among others. IKB invested in the deal regulators are targeting.

The flurry of legal activity is likely to proceed separately from the SEC's case against Goldman, which experts said faces numerous pitfalls. To prove its fraud case against Goldman, the government must show that Goldman misled investors or failed to tell them facts that would have affected their financial decisions. The government's greatest challenge, experts said, will be boiling the case down to a simple matter of fraud. The issues involved are so complex that Goldman may be able to introduce enough complicating factors to shed some doubt on the government's claims.

"If you wanted to go after Goldman with a complaint that wouldn't stick, this would be perfect," said Janet Tavakoli, president of Tavakoli Structured Finance, a Chicago consulting firm. "If you look at these products, almost all of them look like hoaxes because of the junk inside." Legal experts pointed to the paucity of evidence in the government's lawsuit, which contains short excerpts from e-mails but lacks key information about what the various investors knew and what actions they took. The quality of the evidence was not clear from the complaint, said Jacob Frenkel, a former SEC enforcement lawyer now with Shulman, Rogers, Gandal, Pordy & Ecker PA.

Frenkel said there's been an uptick in "cases where the government chooses select excerpts from e-mails as the basis for its allegations only to find the balance of the text or other e-mails prove otherwise." For example, prosecutors last fall tried unsuccessfully to use a series of e-mails to convict two Bear Stearns hedge fund executives. They wanted to convince jurors that there was behind-the-scenes alarm at the hedge funds as investments in complex securities tied to mortgages began to slide. The jurors were not swayed. After the verdict, some jurors told reporters they found the evidence against the two executives flimsy and contradictory. Others suggested the pair were being blamed for market forces beyond their control.

Goldman already has advanced a similar argument. "Any investor losses result from the overall negative performance of the entire sector, not because of which particular securities" were in the investment pool, the bank said in a written response to the charges Friday. That's part of a time-honored tradition of defusing accusations by bringing in details that may or may not be relevant, said James Cohen, a professor at Fordham University School of Law. "Traditionally it's in the interest of the party that has Goldman's role to muddy the waters — it's rarely in their interest to have the picture as sharp as HDTV," Cohen said.

Several legal experts suggested Goldman and the SEC had reached an impasse over a settlement before the charges were announced. They speculated that Goldman was unwilling to admit that it allowed the hedge fund to create a portfolio of securities that was designed to fail because that admission could do irreparable harm to Goldman's reputation. "Goldman could've easily paid a fine already," said John Coffee, a securities law professor at Columbia University. "So I don't think it's money they're fighting over." The case has been assigned to U.S. District Judge Barbara Jones of New York. Jones is the federal judge who five years ago presided over the $11 billion criminal fraud case that toppled WorldCom Corp. and sent its former CEO Bernard Ebbers to prison for 25 years.

Britain launched a probe into alleged fraud by Goldman Sachs four days after the United States shocked markets by accusing Wall Street's most powerful investment bank of duping clients. The U.S. Securities and Exchange Commission (SEC) has accused Goldman of hiding from investors the fact that U.S. hedge fund Paulson & Co was betting against a subprime mortgage product that it helped create.

Britain's Financial Services Authority (FSA) said on Tuesday it had started a formal investigation into Goldman Sachs International in relation to the SEC allegations, and will work closely with its U.S. counterpart. UK Business Secretary Peter Mandelson said: "We have got to look at the whole system of constituting and regulating banks. "We need a system of regulation, a system of levying banks, which is internationally applied," he said on BBC Radio.

Nick Clegg, leader of the Liberal Democrats, the UK's third-largest party, said: "(The allegations) are a reminder, if we needed one, of the recklessness and greed that disfigured the banking industry as a whole. "We believe that Goldman Sachs should now be suspended in its role as one of the advisers to the government until these allegations are properly looked into." Goldman, which is denying the charges, posted blockbuster earnings on Tuesday. Its shares were up 1.4 percent in U.S. premarket trade, after a drop of more than 10 percent on Friday.

The FSA's move draws it in to what promises to be one of the biggest legal rows in recent banking history, and both the SEC and Goldman are expected to come out fighting. In documents submitted to the SEC last year, Goldman said the regulator was using "the benefit of perfect hindsight" about the magnitude of the sub-prime housing crisis and that there was "nothing unusual or remarkable" about the transaction.

The documents, a copy of which were seen by Reuters, told the SEC in September that if the matter was litigated a fuller record "will underscore that no one in fact considered Paulson's role important and that no one was misled." The SEC notified Goldman in August through an official "Wells Notice" that it was facing a civil liability case. The SEC has accused Goldman and one of its bankers, Fabrice Tourre, of defrauding investors by mis-stating and omitting key facts about a collateralized debt obligation (CDO) tied to the sub-prime mortgage market, whose value collapsed.

Investors including banks, pension funds and local governments lost billions of dollars on complex structured products like the one in the SEC case against Goldman, and many are considering legal action. German bank IKB said on Monday it was considering action after losing almost all of the $150 million it put into the Goldman mortgage securities product being probed by the SEC.

U.S. insurer AIG is considering pursuing Goldman over losses incurred on $6 billion of insurance deals on mortgage-backed securities, the Financial Times said. "I've always been slightly surprised that investors haven't gone after the investment banks in the way they did after the Internet bubble. It seems like it is just starting," said Bruce Packard, analyst at Seymour Pierce in London.

Goldman's defence document in September said all participants were highly sophisticated institutions and downplayed the role of Paulson & Co in the selection process, which lies at the heart of the SEC's case. John Paulson's firm made billions from betting on the U.S. sub-prime market collapse, including about $1 billion by betting against the Goldman CDO, according to the SEC.

Goldman said Paulson, was "at the time a relatively unknown hedge fund manager." The overseas support comes as U.S. President Barack Obama prepares to press on with what would be the biggest crackdown on the financial industry since the Great Depression. British Prime Minister Gordon Brown on Sunday said he wanted a UK probe into Goldman and accused it of "moral bankruptcy," but he had no power to force one. Germany's regulator has said it could pursue Goldman.

John Paulson hasn't been accused of any wrongdoing. But the hedge-fund billionaire has gone on the offensive to reassure investors that his huge firm will emerge unscathed from a case that has drawn him into a political and legal vortex.The steps, including a conference call with about 100 investors late Monday, come amid indications from some clients that they might withdraw money from his firm after a lawsuit brought by the government against Goldman Sachs Group Inc. related to an investment created at his firm's request.

Investors have indicated they are concerned that scrutiny over the firm's deals may spread, including to overseas regulators. They said they wanted to protect themselves in case new information emerges that could damage the hedge fund, they say. Another issue, they say: The legal case could simply prove a distraction for Mr. Paulson. "Some of the callers asked pointed questions, almost like a court inquisition, but most people were supportive," said Brad Alford, who runs Alpha Capital Management. "I felt reassured that he did nothing wrong." "It's not a rush for the doors," said another investor in Paulson & Co. who has communicated with larger Paulson investors since Friday, when the government unveiled its Goldman case.

Mr. Paulson sent a letter to investors Tuesday night saying that in 2007 his firm wasn't seen as an experienced mortgage investor, and that "many of the most sophisticated investors in the world" were "more than willing to bet against us." Mr. Paulson's firm focuses on largely liquid investments, or those that are relatively easy to sell without pushing prices much lower. Even if a number of investors ask out, the firm likely will be able to sell investments without crippling their holdings, investors say.

Some traders have been examining Mr. Paulson's top holdings and positions in which filings indicate he has been a substantial holder since the news, they say. When the news of the lawsuit broke on Friday, some of these stocks, including Conseco Inc., Cheniere Energy Inc. and AngloGold Ashanti Ltd., fell sharply. The case has delayed the planned initial public offering of a Canadian investment fund, Propel Multi-Strategy Fund, which was formed to give individual investors exposure to two funds advised by Paulson, according to people familiar with the offering. Propel didn't respond to requests for comment.

On the Monday night conference call, some investors asked if Mr. Paulson or anyone at the firm had received a government notice of potential civil charges, called a Wells notice, according to people familiar with the call. Mr. Paulson said no. Mr. Paulson said the case wasn't a distraction that was affecting the firm's investments, and that he was confident the public glare would abate. On the conference call, Mr. Paulson calmly explained the trade with Goldman, which involved a "short" bet on mortgage bonds. He said that the very nature of the transaction required both a "long" and "short" investor, suggesting that investors knew that a bearish investor had bet against the deal.

Mr. Paulson suggested to clients that the large investors who purchased the Goldman deal and others relied on rating firms, and didn't do enough of their homework, investors say. The hedge-fund firm has a deadline next Friday for investors who want to withdraw money on June 30. Paulson allows most investors to pull out four times a year, but they need to give at least 60 days notice. Investors can cancel redemptions before the end of June.

Magnetar Capital LLC, another hedge-fund firm that, like Paulson, was heavily invested in collateralized debt obligations in 2007 also has been working to reassure investors that it believes its mortgage-linked investment strategy was sound and can withstand regulatory scrutiny. Investors in Magnetar, which oversees some $7 billion in assets, also have a deadline next week to request June withdrawals of money. The Evanston, Ill.-based firm sent an 11-page letter to investors Monday saying that it didn't control which individual assets went into CDO deals in which it invested.

It isn't clear whether ongoing scrutiny of Magnetar will rattle its investors, who have known some details of the firm's strategy for several years. An article earlier this month in news outlet ProPublica was the latest to assert that Magnetar designed deals built to fail that caused cascading losses for investors on the other side of the trades. The hedge fund's strategy was also the subject of a January 2008 Wall Street Journal article. Magnetar told investors this week that it based its mortgage-CDO strategy on statistical models, not a fundamental belief that the housing market would slide.A Magnetar spokesman said, "Our communications with investors have been very positive and supportive."

The Securities and Exchange Commission, after having hit Goldman Sachs Group Inc. with a civil fraud charge, is investigating whether other mortgage deals arranged by some of Wall Street's biggest firms may have crossed the line into misleading investors. The SEC's case against Goldman Friday has exposed an open secret on Wall Street: As the housing market began to wobble a few years back, some big financial firms designed products aimed at allowing key clients, such as hedge funds, to bet on a sharp housing downturn.

Among the firms that created mortgage deals that soon went sour were Deutsche Bank AG, UBS AG and Merrill Lynch & Co., now owned by Bank of America Corp. It isn't known what deals the SEC is investigating. Further cases could hinge on whether the SEC sees what it considers misrepresentation, and not just questions such as whether a deal favored one client over another. A critical part of the SEC's case against Goldman is that the firm allegedly misled investors by not notifying them of the role of hedge-fund investor John Paulson—who was dubious of the housing boom—in selecting what went into the mortgage deal Goldman sold. Goldman said it fully disclosed the investments and didn't need to reveal the Paulson connection.

The deals generated about $1 billion in total fees for the firms, traders say. Investors that bought them often lost heavily. Now private lawsuits, along with the SEC's case against Goldman, are shedding light on how some of these mortgage deals were put together. Soured mortgage investments helped trigger the near-collapse of American International Group Inc., which had insured at least $1 billion of bond deals issued by Wall Street firms in 2005 that reflected hedge funds' input, according to documents reviewed by The Wall Street Journal and people familiar with the matter. Taxpayers had to foot the bill for AIG's rescue.Ultimately, the problems landed at American doorsteps. Losers in the mess included, for instance, a county in Washington state. On Friday, SEC enforcement director Robert Khuzami said the agency will look closely at mortgage deals similar to the Goldman one that is the focus of the SEC action.

At the center of the scrutiny are instruments called collateralized debt obligations. These are typically instruments backed by bundles of mortgage bonds and other assets, including complex derivatives based on the bonds' performance. In the late stages of the housing boom, some hedge funds that doubted its staying power worked with banks to create CDOs that would provide them with a way to bet against the mortgage market. Often the hedge funds bought insurance-like contracts, called credit-default swaps, that would rise in value if the bonds, and thus the CDOs, weakened.

In the Goldman structure at the center of the SEC complaint, credit-rating firms downgraded 99% of the underlying mortgage securities by January 2008. Some CDOs created by Deutsche Bank, Merrill and UBS also suffered downgrades to most of their assets by early 2008, according to analyst reports. Deutsche Bank's traders and bankers were on alert for problems in the housing industry as early as September 2005, well before the market cracked, when a top-ranked mortgage-securities analyst at the bank issued a report warning of pending losses in subprime loans. That report, issued after the analyst visited firms that service mortgages in California, said it would be "sensible" to buy credit protection against mortgage-bond defaults.

From 2005 through late 2006, the U.S. securities arm of Deutsche Bank created several CDOs that sold credit protection on mortgage bonds that the firm's hedge-fund clients bet against, according to people familiar with the matter. Deutsche Bank facilitated the deals, earning fees, by selling credit-default swaps to the hedge funds and clients. To offset its risk, the bank itself bought swaps that would pay off if mortgages backing the CDOs weakened. Among the hedge-fund clients was one run by Mr. Paulson, the investor the SEC says helped pick the assets for a Goldman CDO. His firm, Paulson & Co., which reaped billions on the mortgage meltdown, helped choose about 100 mortgage assets for some of Deutsche Bank's CDOs, traders say. Deutsche Bank used some but not all of his recommendations, according to people familiar with the transactions.

Investors who bought slices of the CDOs weren't explicitly told about the bets by the hedge funds, though they were shown a list of mortgage bonds on which swaps had been written, according to people familiar with the matter and marketing documents reviewed by The Journal. The Deutsche Bank CDOs were called Static Residential CDOs (nicknamed "START"). Those CDOs took bullish positions on mortgage bonds that hedge-fund clients bet against.

Many mortgage bonds underlying the Deutsche START deals were downgraded by rating agencies and tumbled in value after loan delinquencies rose. Deutsche Bank's hedge-fund clients profited when insurance on those bonds rose in value. A spokesman for Deutsche Bank said all participants in the deals, not just Paulson, provided input on which mortgage securities backed its CDOs. A spokesman for Mr. Paulson said, "Every single synthetic CDO has a party on the long and short side."

Some sophisticated traders and Wall Street firms were early to spot the impending end of the housing boom. In January 2007, a New York money manager, Tricadia Capital, told investors in a hedge fund it managed of "serious cracks" beginning to appear. In a letter to investors reviewed by The Wall Street Journal, it said 2007 "may well be the year in which the great structured credit trade unwinds with profound implications for markets around the world." The fund, the firm's officials said, was positioned "to benefit from a dislocation in the credit markets." Another Tricadia unit, whose job was to manage CDOs, was working with banks, including UBS, to create new asset pools predicated on the housing market's doing well. Tricadia had responsibility for selecting the mortgage assets.

A document for one $2.25 billion CDO, called "TABS 2007-7," underwritten by UBS, did warn that other funds managed by Tricadia or its affiliates might make bearish bets on the same assets, an offering document shows. Less than a year after it was formed, the deal was liquidated, after the downgrade of most of its underlying assets. Losing investors included a bank in California and UBS itself. But in 2007, the hedge fund Tricadia managed reaped strong gains. A spokesman for Tricadia said it "has always acted in the best interests of its clients and investors" and did not make negative bets on the same assets backing the TABS 2007-7 deal.

Hedge fund Pursuit Partners LLP, which lost money on several UBS-underwritten CDOs, including TABS, alleges in a pending lawsuit against UBS in state court Stamford, Conn., that UBS knew assets backing the CDOs were souring when it was marketing the deals in the summer of 2007. A lawyer for Pursuit says it was contacted about the suit by the SEC and Justice Department. Both declined to comment. UBS, which has denied wrongdoing in the suit, declined on Sunday to comment.

Among investors in Abacus, the Goldman transaction the SEC focused on, was an affiliate of Germany's IKB Deutsche Industriebank AG, which put in $150 million. The affiliate, Rhineland Funding Capital Corp., issued its own short-term IOUs, to investors such as King County in Washington State and a suburban Minneapolis school district. Just months after Abacus closed, the investment by the IKB affiliate was nearly worthless and the affiliate couldn't renew maturing IOUs. That ultimately harmed U.S. towns and cities that had invested in debt sold by Rhineland.

Washington state's King County has sued IKB claiming that unknown to the county, an IKB affiliate held many "toxic, low-quality mortgage-backed securities." IKB is fighting the suit, pending in federal court in New York. An IKB spokeswoman declined to comment on the case. Another hedge fund, Magnetar Capital in Evanston, Ill., worked in 2005 and 2006 with Merrill, Deutsche Bank and other firms to set up CDOs. One was a CDO called Norma, underwritten by Merrill. That deal, the subject of a page one Wall Street Journal article in December 2007, was a $1.5 billion assemblage of mortgage securities and credit-default swaps on subprime assets. Magnetar, a Merrill client, bought the riskiest slice of Norma and made bearish bets against slightly less risky layers of CDOs.

A money manager Merrill had hired to pick the assets to put in Norma told the Journal in 2007 that most had been pre-selected. A review of the assets showed they included swaps bets opposite to the negative wager Magnetar made. As losses increased, Magnetar profited. The Dutch bank, commonly known as Rabobank, sued Merrill last year in a New York state court, alleging that Merrill misrepresented the safety of Norma, which it called a "dumping ground" for impaired subprime assets, structured with the help of Magnetar. Merrill denied wrongdoing and has sought dismissal of the suit. On Friday, Rabobank asserted in court that Merrill and Magnetar effectively had engaged in the "same type of fraudulent conduct" the SEC accused Goldman of.

A Merrill spokesman said Sunday it provided all information required by Rabobank in the Dutch bank's decision to invest in the CDO. The spokesman added that Rabobank had access to information about the bonds underpinning the CDO, and disclosures were provided. A spokesman for Magnetar said that it hadn't seen the Friday court filing and that the original complaint "made a variety of false and inaccurate statements about Magnetar and its investment in CDOs." The spokesman added that "Magnetar's investments in CDOs were based on a statistical strategy and expressed no fundamental view on the direction of the market. Any characterization to the contrary is incorrect."

Goldman Sachs Group Inc., facing a fraud lawsuit from U.S. regulators, said it would never intentionally mislead investors. "We would never intentionally mislead anyone, certainly not our clients or our counterparties," Goldman Sachs Co- General Counsel Greg Palm said today on a conference call with analysts. "We have never condoned and would never condone inappropriate behavior by any of our people. On the contrary, we would be the first to condemn it and take all appropriate action."

‘‘Our responsibilities as a financial intermediary require it and our commitment to integrity and the firm’s business principles demand it,’’ Palm said. Palm said Goldman Sachs had ‘‘no incentive’’ for the deal to fail, and lost more than $100 million on the transaction.

Goldman Sachs has been drawn into a fresh controversy as lawyers demand to know whether it was partly responsible for triggering Lehman Brothers’ downfall by shorting its rival’s shares. The Wall Street behemoth is already being investigated by a number of financial regulators around the world in addition to the US Securities and Exchange Commission’s fraud charges over derivatives mis-selling. It has now been named in a court filing seeking information about short-selling Lehman shares.

Goldman has been subpoenaed to hand over documents to Lehman’s Bryan Marsal, the man responsible for winding up the bank’s affairs and repaying creditors. Goldman was named in the court filing along with four other firms, including hedge funds SAC Capital and Citadel. Goldman declined to comment on the Lehman case. In a further potential legal case, it emerged that AIG is considering suing Goldman over about $2bn (£1.3bn) of losses it incurred from past derivatives instruments. The troubled insurer is understood to be considering action as a result of protection it was forced to pay to buyers of credit-default swaps when collateralised debt obligations (CDOs) in Goldman’s Abacus programme lost their value.

The new worries came as Goldman hit back against the SEC’s charges, which it said are "completely unfounded both in law and fact". Questions were last night being asked as to why the bank had not publicly disclosed the regulator’s probe. It is understood Goldman was first contacted by the US financial watchdog over its examination of mis-selling in the mortgage-backed securities industry two years ago, and that it received what is known as a "Wells Notice" – an intention to file charges – as early as July last year.

Goldman has filed 8m documents with the SEC in relation to the investigation, and five of its staff were interviewed as part of an exchange which saw the bank attempt to defend its point of view. Lloyd Blankfein, the bank’s chairman, has been attempting to boost staff morale ahead of today’s first-quarter results, which are expected to show a profit of as much as $3.8bn. "The extensive media coverage on the SEC’s complaint is certainly uncomfortable, but given the anger directed at financial services, not completely surprising," he said in one voicemail left on an employee’s phone.

Fabrice Tourre, the bond trader at the heart of the SEC’s probe, has begun an undetermined period of absence. The bank maintained that while he has done "nothing wrong" and remains an employee, he had made a "personal decision to take a bit of time off". President Barack Obama is to make a landmark speech on financial regulatory reform which is expected to draw on Goldman’s current problems. Both BaFin, the German regulator, and the European Union are looking into the situation.

"Surreal" was the word Goldman Sachs Group's Fabrice Tourre used to describe a meeting in which the firm of hedge-fund billionaire John Paulson discussed with an investor a portfolio of mortgage-backed securities it eventually planned to short. That Goldman Sachs, a name once synonymous with professionalism and integrity, now stands accused by the Securities and Exchange Commission of fraud might also be deemed surreal.

It's hard to imagine the damage that these developments have already done to Goldman Sachs's reputation. The company has always maintained a public position that the business of investment banking depends on trust, integrity and putting clients' interests first.

Whether those clients remain loyal to Goldman, and whether the firm can attract new ones, remain to be seen. Investors' reaction to the news was swift and negative: Goldman shares closed down 13% Friday after the SEC filed its suit. Goldman says it is innocent and will fight the accusations. The bank deserves its day in court, and legal experts have said the SEC faces a tough task in proving the company misled investors about how its complex investment vehicles were constructed. Given the public anger at Wall Street, and the criticism of the SEC's failure to regulate more effectively before the financial crisis struck, it's worth considering that Goldman makes an enticing political target, regardless of the merits of the suit.

Goldman hasn't disputed the basic facts in the SEC's narrative: (1) that the company allowed its client Mr. Paulson, who famously made billions betting that subprime mortgages would default, to play a role in the selection of a portfolio of the worst imaginable subprime mortgages that would be packaged into a collateralized debt obligation, and (2) that the bank failed to disclose to clients to whom it sold those CDOs that it had, in effect, let the fox into the henhouse. Goldman claims its sophisticated clients wouldn't have cared about such information or considered it important, but if that's the case, why did Goldman conceal it? Goldman collected millions of dollars in fees from Mr. Paulson, who bet against the doomed securities, and from the clients who invested in them.

For many years, I was a Goldman Sachs shareholder. I bought shares soon after the firm went public in 1999 and held them until I sold them last year, as I reported in this column. I owned them and recommended them on several occasions because I believed in Goldman's integrity and the culture that fostered it. I have had friends who work at Goldman or who have worked there. To me, they embody the best of Wall Street. They're smart, well-educated, thoughtful, professional and hard-working. This is the Goldman I invested in, not the Goldman alleged to have collaborated with someone like Mr. Paulson to hoodwink investors. I'm not even that concerned about whether the Paulson deal passes legal muster. To me, it fails the higher standards of honesty and professionalism that Goldman once embodied and urgently needs to restore. Then, and only then, would I want to own Goldman shares again.

In its first-quarter earnings conference call Tuesday morning, the company continued to deny wrongdoing and cited its net losses on the deal. Greg Palm, the firm's general counsel, said Goldman "would never intentionally mislead anyone," and that the company "would never condone inappropriate behavior."

To regain investor trust, Goldman must abandon conventional public relations and legal strategies that call for an all-out defense. It should stop saying it will fight the charges aggressively and that the SEC's suit is "completely unfounded." No matter how wronged Goldman officials now feel, they must put those feelings aside and view this matter from the perspective of clients, investors, politicians and the public. Goldman's mantra should be cooperation, not defiance.

When an institution depends on trust and is accused of wrongdoing, it needs to get ahead of the investigators. It needs to learn the facts, share them with the public, impose accountability on its employees, and take any steps necessary to remedy the problem and restore trust. I say this as someone who has written about wrongdoing on Wall Street for years and watched once venerable firms like Kidder Peabody and Drexel Burnham Lambert ignore such advice and pass into oblivion.

This need not be Goldman's fate. It's already unfortunate that we've learned about the Paulson deals from the SEC and the press rather than from Goldman itself, especially because the firm says it's been on notice since last July that it might be sued. But it's not too late for the firm to move boldly to restore trust. Goldman needs to explain:

• Why was a firm like Mr. Paulson's allowed to choose the securities in the CDO it was planning to bet against? Although Mr. Paulson's firm may have been smart to bet against subprime mortgages, this deal was like shooting fish in a barrel. Who else gets this kind of access, what does Goldman receive in return, and are their roles disclosed? (Though Mr. Paulson hasn't been accused of any wrongdoing, it would be interesting to know how much money from the Troubled Asset Relief Program paid to Amercan International Group, Goldman and others ended up going to him.)

• Who at Goldman was responsible for giving Mr. Paulson such extraordinary access and then failing to disclose it? Surely it wasn't Mr. Tourre, the 31-year-old Stanford graduate named as a defendant in the SEC suit. Who did he report to? What was the hierarchy of oversight? In other words, where does the buck stop?

• Legal issues aside, does Goldman really believe this deal meets its own standards of integrity, fairness, and professionalism? The notion that purchasers of the securities wouldn't care about Mr. Paulson's role already fails the common-sense test. Such an argument would be far more persuasive if it came from the clients who bought them rather than Goldman. And it's no excuse that other firms were carrying out similar deals with comparable disclosure.

• If Goldman concludes such a deal didn't meet its standards, it needs to acknowledge that and take whatever steps are necessary to prevent it from happening again. Someone has to be responsible and held accountable, perhaps even a highly valued and revered high-level official. Goldman needs to do this before it is forced to do so by a court, regulators or Congress. This will be painful. It takes courage, objectivity, vision, and perhaps most of all, humility.

• How will Goldman prevent such conflicts in the future? What is it doing internally to restore a culture of integrity? If Mr. Tourre or any other employee thought he was caught in a "surreal" situation, to whom could he take such concerns and get a fair hearing?

• The SEC suit isn't Goldman's only potential scandal. The Wall Street Journal reported last week that Goldman director Rajat Gupta is being investigated as part of the sprawling Galleon insider-trading investigation. In the article, Goldman declined to comment on whether Mr. Gupta informed the company about having received a notice from prosecutors. What does Goldman know about possible leaks of inside information? Why, when Mr. Gupta told Goldman in March he wouldn't be standing for re-election, did Goldman chief executive Lloyd Blankfein issue a public statement lavishing praise for his service? And why, for that matter, wasn't Mr. Gupta asked to resign immediately? Mr. Gupta hasn't been accused of wrongdoing, and Goldman is right not to prejudge him. But that doesn't mean Goldman should ignore the evidence or that someone under investigation is entitled to a board seat.

• Are there other investigations we should know about?

These may well be isolated incidents, confined to a few individuals, their timing an unfortunate coincidence. If so, Goldman has all the more reason to get ahead of the scandal, get the facts and disclose them. It may require swallowing some pride and suffering some criticism. It's also the right thing to do.

James B. Stewart is a columnist for SmartMoney magazine and SmartMoney.com

Commercial-Mortgage Defaults Ripple Out; Restructuring Into Good and Bad

Defaults on commercial mortgages bundled into securities are climbing to records, threatening bondholders with steeper losses and putting pressure on property owners and lenders to restructure their loans. According to Fitch Ratings, more than 11% of some $536 billion of loans packaged into commercial-mortgage-backed securities are expected to be at least 60 days past due by year's end. The late-payment rate now is about 7% and has skyrocketed in the past year because of squeezed rent payments, making it hard for property owners to continue servicing their debt and the near-paralyzed market for new commercial-mortgage-backed securities, which is making it impossible to refinance some debt as it comes due.

Among securities facing big problems is a $4.2 billion CMBS deal underwritten in 2006 by Goldman Sachs Group Inc. and Royal Bank of Scotland Group PLC unit Greenwich Capital. The deal is expected to see an 11.7% loss, the highest of any 2006 CMBS issue analyzed by Fitch. Like residential-mortgage-backed securities, the commercial variety was a Wall Street creation used heavily by the real-estate industry during the boom. Before the real-estate bubble burst, the default rate had been less than 1%.

Now the misery in the CMBS market is heading toward a reckoning. About $70 billion in loans are in the hands of so-called special servicers, or companies that represent holders of commercial-mortgage-backed securities with underlying loans that are in default or imminent default, according to Deutsche Bank AG. Servicers have restructured about $13.7 billion of those loans, according to estimates by analysts at Deutsche Bank. Such restructurings, which include extending loan maturities and reducing interest rates, could help bondholders and borrowers avoid bigger losses as the economy recovers. But some borrowers still wind up defaulting.

Such firms—including LNR Property Corp., owned by private-equity firm Cerberus Capital Management LP, and CW Capital, majority-owned by Canadian pension manager Caisse de Dépôt et Placement du Québec—are "going to trot out the entire playbook" used during the real-estate crash of the early 1990s, said Mark Warner, a managing director at BlackRock Inc. One emerging restructuring strategy involves cutting mortgages into good and bad pieces. For example, Grossman Company Properties was in danger about a year ago of defaulting on the $190 million mortgage for its Arizona Grand Resort in Phoenix, which is suffering from a decline in business and leisure travel.

The loan, originated by Greenwich Capital, was part of the Goldman/Greenwich deal in 2006, which also includes troubled loans on an office complex in downtown Los Angels and six retail stores. Grossman is led by real-estate investor Sam Grossman, who made a name for himself by snapping up distressed assets in the early 1990s. After months of negotiations with CW Capital, Mr. Grossman's company struck a deal allowing it to keep the property in return for a $5.8 million capital infusion.

The original Grossman loan was split into two parts, with the cash flow from the 640-room resort, equipped with two golf courses and a water park, now used only to service the debt on the $100 million part of the loan, Deutsche Bank said. The second slice, totaling $90 million, will get no payments until the loan matures in 2016 and the first part of the loan gets paid off. The net effect of this restructuring is that it allows the subordinate bondholders to avoid taking a loss before the loan matures while delaying the recoveries for senior bondholders, Deutsche Bank analysts note. Supporters of the restructuring said the move was in the best interest of all bondholders and the borrower because liquidating the property likely would have resulted in large losses.

It isn't clear if the resort will perform well enough even with the eased debt burden, according to a person familiar with the matter. Matthew Crow, president of Grossman Company, said the loan is "is current and performing, and we expect to stay that way in the restructured form."

A successful short-term bond auction by debt-ridden Greece soothed some market concerns, but a jump in the country's 10-year yields to the highest level in 11.5 years underscored persistent fears about its ability to meet its borrowing needs. Greece raised €1.95 billion ($2.63 billion) through a three-month Treasury- bill auction to yield 3.65% amid strong demand. Combined with a sale of six-month and 12-month bills sold a week ago, Greece is expected to have met its April debt payments. With Greece's planned dollar-bond issuance uncertain amid lackluster interest from U.S. investors, the government may decide to tap the safety net provided by the European Union and the International Monetary Fund by then.

Although short-term and longer-term yields fell briefly after the auction, the country's benchmark 10-year yield still ended at 7.667%, its highest closing level since November 1998 and up from 7.655% on Monday.. The extreme volatility in Greek yields is a result of postponed financial-aid talks due to the air-traffic chaos caused by Europe's ash-clouded skies. Talks in Athens were supposed to start Monday with representatives of the EU and the IMF. The EU earlier this month agreed to a €30 billion aid package to which the IMF is expected to add an estimated €15 billion. The EU's spokesman for Monetary Affairs, Amadeu Altafaj, said the talks probably would start Tuesday or Wednesday and could take two to three weeks to complete.

The 3.65% yield realized at Tuesday's sale pleased the Greek Public Debt Management Agency as it came in below 4%, a figure that only the most optimistic market players had expected. "We are very pleased with the outcome, given the strong investor demand shown in the solid over-coverage," said Petros Christodolou, chief executive of the Public Debt Management Agency. "The yield is of course higher than the rate we achieved in January, but one should remember that it is at a lower spread over Euribor than the last two auctions," he said. The yield on the bills was below secondary market levels of around 4.7% Monday but above the 1.67% Greece paid at the three-month T-bill auction in January. After the auction they traded between 4% and 4.7% and compared with July-dated German Treasury bills around 0.25%.

"The auction was a success but it is not a game changer," said the head of trading at a major local bank in Athens. "It just doesn't mean very much given the current state of affairs," he said, adding that liquidity is still poor on the market. The Greek Public Debt Management Agency offered €1.5 billion of the three-month T-bills and the amount sold includes noncompetitive bids submitted for up to 30% of the auction amount, bringing the allocated amount to €1.95 billion. Bids totaled €6.921 billion.

The Bank of Canada signaled it may be first in the Group of Seven to increase borrowing costs, joining other countries such as India and Australia, as economic growth accelerates and stokes inflation. In its decision today to leave the lending rate at a record low 0.25 percent, policy makers dropped a phrase about a "conditional commitment" to keep it unchanged until July unless the inflation outlook shifted. The bank said inflation will be "slightly higher" than its 2 percent target over the next year, and increased its 2010 economic growth forecast to 3.7 percent from 2.9 percent.

The Canadian dollar jumped as much as 1.6 percent as the new language suggested the bank may increase rates as early as its next announcement on June 1. The two-month overnight index swap rate, a measure of the average overnight rate expected by investors during that time, rose to 0.3315 percent, the highest in a year. "With recent improvements in the economic outlook, the need for such extraordinary policy is now passing, and it is appropriate to begin to lessen the degree of monetary stimulus," the central bank, led by Governor Mark Carney, said in a statement today from Ottawa. "The extent and timing will depend on the outlook for economic activity and inflation."

The Canadian dollar gained 1.6 percent to C$0.9987 against the U.S. dollar at 10:45 a.m. in Toronto, from C$1.0144 yesterday, which was the weakest level since March 30. Today’s statement "certainly allows for a move in June," said Paul Ferley, assistant chief economist at Royal Bank of Canada in Toronto. "It’s removing an impediment for them to move depending on the data." The bank today also advanced its prediction of when the economy will reach full capacity to the second quarter of next year from the third quarter.

"This statement cements a June 1 hike," said Derek Holt, an economist at Scotia Capital in Toronto, adding the announcement "screams hawkish." Holt expects the central bank to raise its benchmark interest rate to 1.50 percent by the end of this year and 3 percent by the middle of 2011. Canadian Imperial Bank of Canada advanced its prediction for a rate increase to June from July after today’s statement. Inflation excluding eight volatile items, known as the core rate, will "remain near 2 percent" through 2012, the bank said. The Bank of Canada predicted in January that core and total inflation wouldn’t reach 2 percent until the third quarter of next year.

Economic growth is more "front-loaded," the bank said, reducing its forecast for next year to 3.1 percent from 3.5 percent, and making its first projection for 2012 growth of 1.9 percent. Growth is being fed by a recovering global economy, "very strong housing activity" and government stimulus, the bank said in its statement. Canada has benefited from rising demand for copper, gold, wheat and oil from the U.S. and emerging economies such as India and China. Even automobile and lumber companies -- among the hardest hit last year by the recession-- are seeing a rebound. General Motors Co. said March 26 it plans to add a third shift at its Oshawa, Ontario, plant.

"The North American auto industry has seen some resurgence in inventory levels since the fall of last year," said John Amodeo, chief financial officer of Samuel Manu-Tech Inc. in Toronto, a maker of steel and plastic goods. To be sure, Canada’s economy hasn’t made a complete recovery from last year’s recession. High unemployment lingers and the Canadian currency’s rise to parity with the U.S. dollar could slow exports later this year. "We are seeing mixed signals from the consumer," said Duncan Reith, senior vice president of merchandising in Toronto at Canadian Tire Corp., the nation’s largest auto parts and sporting goods merchant. "They are watching their pennies still very carefully."

Growth will be slowed by the strong Canadian dollar, a low level of U.S. orders and sluggish labor productivity, the Bank of Canada said today. The bank will present a full forecast in its monetary policy report on April 22. Holt at Scotia Capital said the bank’s long-run growth concerns in today’s announcement are "a way of signaling a lower neutral rate coming out of this cycle." "We have transitioned away from the need for emergency rates, but they are saying we will still need lower rates for the long-term," he said. The bank also said today it is ending its term purchase and resale agreement program, which aimed to ease trading in tight credit markets and reinforce the conditional commitment to keep the policy rate at 0.25 percent.

Public guarantees in the wake of the global crisis have been wide-spread. This column presents recent research on the effects of a 2001 law to remove government guarantees for German banks. It finds that such guarantees were associated with significant moral hazards and removing them reduced the risk taking of banks, their average loan size and their overall lending volumes.

Do public guarantees influence bank risk taking? Public guarantees in the wake of the global financial crisis have been widespread. Many countries either nationalised banks (such as the US: Indy Mac, Fannie Mae, Freddy Mac; UK: RBS, HBOS, Lloyds; Germany: IKB, Hypo Real Estate; Belgium/Netherlands: Dexia, Fortis), or they provided blanked guarantees for the banking system (such as Germany and Italy) or both (Beck et al. 2010, Aït-Sahalia et al. 2009).

Despite this prevalence, there is scarce evidence on the likely effect of such interventions on bank risk taking.

This column reports recent research on the effects of public guarantees on bank risk taking and provides direct evidence that public guarantees are associated with substantial moral hazard effects.

Likely effects of public guarantees

Theory tells us public guarantees will have two opposing effects on bank risk taking. On the one hand, government guarantees may reduce market discipline because creditors anticipate their bank's bailout and therefore have lower incentives to monitor the bank's risk taking or to demand risk premia for higher observed risk taking (e.g. Flannery 1998, Gropp et al. 2006, Sironi 2003). This tends to increase the protected banks' risk taking. The effect is similar to the well-known moral hazard effect discussed in the deposit insurance literature (e.g. Merton 1977, Ruckes 2004). If depositors are protected by a guarantee, they will punish their bank less for risk taking, thus reducing market discipline.

On the other hand, government guarantees also affect banks' risk taking through their effect on banks' margins and charter values. Keeley (1990) was the first to argue that higher charter values decrease the incentives for risk taking, because the threat of losing future rents will act as a deterrent. Government bailout guarantees result in higher charter values for protected banks that benefit from lower refinancing costs. Hence, government guarantees may alternatively be viewed as an implicit subsidy to the banks that, through their future value, decrease bank risk taking.

Ultimately, the net effect of government bailout guarantees on the risk-taking of banks is ambiguous and depends on the relative importance of the two channels.

Whichever dominates is an empirical matter.

In 2001, government guarantees for savings banks in Germany were removed following a law suit. We use this natural experiment to examine the effect of government guarantees on bank risk taking, using a large data set of matched bank and borrower information.

Our data

We use a proprietary data set provided by the German Savings Banks Association for the years 1996 to 2006 which symmetrically spans the removal of government guarantees in 2001. The data set provides annual balance sheets and income statements of all commercial loan customers of all 457 German savings banks affiliated with the German Savings Banks Association. It includes data for over 87,000 customers. In total there are over 230,000 observations in the data set. The borrowers are largely small- and medium-sized enterprises with an average of €1.6 million in total assets. To control for savings bank characteristics, we also use annual balance sheets for the 457 savings banks. The savings bank data is also from the German Savings Banks Association.

As a measure for the credit risk at the borrower level we use Altman's Z-Score (Altman 1968) calibrated to the German banking market. In addition we analyse the effects of the removal of public guarantees on loan size, the charged interest rate spread, and the total loan volume.

The approach taken in the paper permits a unique identification of the effects of government guarantees on bank risk taking for a number of reasons.

First, the removal of guarantees was exogenously imposed on the sample banks. The change in the safety net that we examine was unrelated to a financial incident, but rather based on a European court decision.

Second, the banks in the sample are small and, therefore, unlikely to be "too big to fail". Hence, we can exclude the possibility that explicit government guarantees were simply replaced by implicit guarantees, which may have similar effects on bank risk taking and also be associated with moral hazard (Gropp et al. 2009).

Third, the data permit a link between the balance sheet information of the banks and the balance sheet information of their commercial loan customers. Savings banks largely operate along traditional banking lines with little off-balance sheet operations.

Hence, we are able to measure their risk taking comprehensively by examining the Z-Score of their commercial loan customers.

The main findings

Our main findings can be summarised as follows:

· The removal of government guarantees not only significantly decreased the risk taking of banks (the Z-Score of average borrowers increased by 7%), but we also show that after the removal of guarantees, banks reduced average loan size (by 13%) and overall lending volumes (by 22%). Riskier borrowers were either denied credit or were given a smaller loan. At the same time, banks increased interest rates for loans on the remaining borrowers (plus 57 basis points), despite their higher quality.

· We find that these effects tend to be significantly larger for banks, where it is likely that the ex ante value of guarantees was higher. First, the effects are larger for savings banks which were more risky before the removal of state guarantees. Ex ante riskier banks appear to have reduced their risk taking more after the removal of guarantees relative to ex ante safer banks. Second, savings banks which were associated with a more risky federal state bank also reacted more strongly to the removal of public guarantees. Our results show that the reduction in risk, the reduction in loan size, and the increase in interest rate spread were all significantly larger for savings banks that were associated with a riskier federal state bank.

· Finally, we show that the savings banks adjusted their risk taking both by dropping existing risky borrowers from their loan books (monitoring) and by tightening their lending standards for new borrowers (screening). The results suggest that some borrowers – generally the riskiest ones – lost access to credit due to the removal of guarantees

Conclusions

The results in this paper show that government guarantees are associated with strong moral hazard effects. The approach taken in the paper permits a unique identification of the effects of government guarantees on bank risk taking.

37 comments:

I would like to ask why our esteemed hosts studiously avoid the "Last Empire" issue in all of your commentary?

I can see no possible scenario where the massive Corporate Military Industrial Complex, with a dominant presence on every continent, relinquishes their position to ANY other entity. ANd please don't try and explain how they will go BK and go jingle mail.

I can understand how that would significantly change the timber of the conversation but I have to admit to getting a little tired of armchair QB'ing and after the fact commentary.

IMO all of the criticism aimed at ya'all stems from this shortcoming.

It's clear to any who are willing to see that we, the global community of TPTB's, are playing a big game of "Last one Standing" and we WILL win or else...

If we don't start acknowledging this simple fact we will unquestionably end up with "or else..."

Ilargi. When you mention Senator Dodd chairing the Senate Banking Committee and authoring banking reform regulations I cringe and my stomach turns. Here we have a Senator who plays the role of the fox guarding the proverbial hen house.

Linda said...Don't get what happens after the poof. What is turning its back on the dollar? The higher rates & no auctions? So then...I'm missing a step. Sorry I'm not so good at bonds. Linda.

OK as we delve deeper into the matter it can easily happen that what i say becomes inconsistent or simply outright wrong. So i would ask the board members please feel free to interrupt and correct me should that be the case.

First i would point out that in the modern economy most things of value be they a new car or a new office or a new powerplant are normally financed not with savings but with debt. You dont save money to build a new plant, you borrow money to build it. So nearly everything that gets done in our economies involves taking on debt.

Second, once borrowed there is often no urge (or ability) to repay the money back with time, instead the debt is carried on the books and serviced annually with dividends/fees/interest etc. theoretically indefinitely, the borrower hoping to "grow out" of debt instead of repaying it. That is one of the reasons why our economies literally swim in debt and cannot exist without the ability to take even more of it.

A large portion of this debt is borrowed through the issuance of bonds. That is a preferred method of the public sector (states and municipalities) but also actively used by the privat sector as well.

From Wikipedia:In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals.(...)The most important features of a bond are:

* nominal, principal or face amount — the amount on which the issuer pays interest, and which, most commonly, has to be repaid at the end. (...) * issue price — the price at which investors buy the bonds when they are first issued, which will typically be approximately equal to the nominal amount. (...) * maturity date — the date on which the issuer has to repay the nominal amount. (...) * coupon — the interest rate that the issuer pays to the bond holders. Usually this rate is fixed throughout the life of the bond. (...)

So normal bonds have a maturity, a fixed period of time after which the money borrowed MUST be paid back to the lender. The maturities of the bonds relevant for our case range perhaps from one year to ten.

That means that once you borrowed money through the issuance of a bond there comes a day when all this money (plus interest according to the terms of the bond) must be paid back. Since there is often no ability or inclination to do so, the borrower simply issues a new bond and with this money redeems/repays the old one - that is called a "roll over". So far, so good.

Now the bond market gets angry (for some reason) and employs his power. As new bonds come with higher interest not only new debt becomes more expensive for the borrower to carry, but with time ever larger portions of old debt too, since now old debt has to be "rolled over" with new and higher interest rates. At some point the borrower simply has not enough income to pay the fast increasing interest and starts to borrow new money to be able to just CARRY the debt - the beginning of the downward debt spiral invariably endind in disaster(default) barring some intervention from "above".

If the bond market anticipates such an outcome it long before stops buyind new bonds altogether. But the old ones still have to be repaid. With no other source of money that means default.

When it comes to the US (which can also print/create money besides borrowing it) two scenarios or better said processes are possible. Cleanly separated they are as follows:

a) The US borrows ever more ridiculous amounts of money, so the bond market raises rates perceiving increased risk of default. As carrying debt becomes more costly the US borrows even more money entering the debt trap. Eventually the bond market says "enough" and stops buying US bonds. Without access to new debt - "puff" - the US economy defaults - public sector downsizes dramatically, large chunks of the private sector are liquidated, deflation reigns.

b) The FED starts printing/creating money in earnest, the bond market raises the rates perceiving increased risk of inflation. As carrying debt becomes more costly the FED prints even more money causing a runaway inflation. Eventually the bond market says "enough" and stops buying bonds denominated in dollars - "turns its back on the dollar". Without access to new debt the FED begins printing with abandon - "puff" - the US economy indulges itself in hyperinflation, economically isolated from the rest of the world, bartering for imports.

In reality both processes happen at the same time, are intertwined and are influencing each other in strange ways since their very natures are actually in opposition to each other. This is further complicated by the fact that the US is the biggest economy, issuer of a worldwide reserve currency and quite influential in other aspects too.

So how the "puff" and thereafter will actually look like in reality is a big and as yet unresolved mystery (we are probably in the middle of it). Thus the great confusion and an intense debate among economists, pundits, bloggers and all the others.

Why can't the media expose the corruption between gongress persons and lobbyists? On TV, prime time, cameras, microphones, faces, names to face ,what is said, how much money changes hands? Where does this activity take place? Is it completely secret? It MUST be exposed DIRECTLY to the people, why does this not happen". Headly

"We need to subject the laws that govern production and consumption to the laws of Gaia; the laws of the planet. The laws of a planet that can give forever in abundance for our needs if we do not allow the narrow minded, mechanistic, reductionist, greed based system of industrialism, capitalism, globalization to make us imagine that to be inhuman is the definition of being human." ~VANDANA SHIVA

"Those who contemplate the beauty of the Earth find reserves of strength that will endure as long as life lasts." ~ RACHEL CARSON

@ souperman2...you are a man after my own heart- a big picture thinker! Indeed the affects of empire in decline are unavoidable now. TAE commentary of the details, for me, is entirely in support of that big chunk, collapse of Empire.Just this week I have been thinking about the tar sands, all the pipes heading south( not east or west for Cdn use). China's investment comes at a price. Cdns will no longer control the export of tar sands oil. I assume the Chinese will call that play. Here we are with a resource that 2 fueding empires need to maintain hegemony.And here we are with provincial/federal gov'ts quite eagar to sell off and out the country to the highest bidding Empire. One does wonder if that may be the best option available. If Cdns don't sell the resource the fueding Empires will simply take/seize it.History does record such empirical behaviour.I agree completely with you that the CMIC will not stand down. Is there a black swan event than can arrest this death spiral? Nuclear war? That strategy risks not just a losing play but an elimination of the entire game- the end game. Is that what you see?

In a situation like this, it's simply not possible to get sufficient and effective legislation. And no, I'm not sure I know what to do about it either, short of (lots of) pitchforks. But I do think it’s important you realize this for a fact. That in US politics, there's two dogs fighting for a mighty fat bone, and there's no third dog in sight to run away with it. In fact, the two dogs fighting is just a spectacle designed to divert your attention from the backroom deals and envelopes changing hands that are the real action.

souperman2 also adds some valuable insight into why "it's... not possible to get sufficient and effective legislation" out of politics. Of course, I sense to real politik stuff in there that I'm not sure that accept. But the empire piece is indeed critical to understanding our situation.

For me, it all comes down to correctly perceiving the functions of governments. And I think that people are expecting things out of the federal government that it is no longer (if it ever was) designed to do. As souperman2 suggests, it exists to maintain an empire. Concordantly, its officers have achieved their positions usually (almost universally, I think) to enhance their personal prestige and wealth.

There are no political solutions to the things that we would like to see accomplished. Like ilargi, I'm not sure what there is to be done. The first step is for more people to come to these conclusions. Once a sufficient quantity of people believe that political systems (at least current ones) offer no positive solutions, we can go from there. I'd like to hope that pitchforks wouldn't be brought out. But revolution (peaceful or not) would be necessary.

More likely, I see war as a distraction to remind people of their nationalistic loyalties. Once the results of that war shake out, we reset.

He's from Goldman Sachs; and of course no one believes anyone from there. But I wonder if anyone in the TAE audience even reads the other side. His basic argument comes down to two themes:

1) Leading indicators continue to rise worldwide. So far in this little crisis and is denouement, the score is:

Leading indiators: 56Bears and doomers: 0

2) Emerging market growth will carry the world forward. The implication is: those 10% of Americans unemployed don't matter to the economy. They can't consume much anymore, but people from the commodity countries, China etc. will pick up the slack. The American unemployed are truly "redundant" as the Brits like to say. GDP and the markets can rise without them. Maybe they will get a few low-paid jobs back exporting to China and Brazil.

If you follow the argument so far, all you need to worry about is the race between extend-and-pretend in the banking sector and real estate prices. If prices stabilize or rise, Bernanke wins. Note how the commercial REIT indices (e.g. VNQ) are up 1.6% today. Also how near-zero interest on savings encourages people to buy property; and how rise and increasing convertibility of the Yuan could even bring Chinese money into the US housing market (like what is happening in Hong Kong.)

Where is the sudden collapse going to come from? So what if Greece goes down; the market doesn't care. VVVoom ...

The indifference to the Grecian situation is amazing. Took off all my short positions today, save some long dated puts. My buddy with MF Global says fundies are not selling, and even adding as we melt up on the indices. Retail is beginning to jump in hard too. Can't blame them given the paltry return on savings, coupled with the implicit govt backstop of anything Wall Street. Feels a lot like Oct of 07--lots of buyers and few sellers. It's a mania.

J6P should be aware that 'strategic default' is a business decision.http://seattletimes.nwsource.com/html/businesstechnology/2011668875_beacon22.html Region's biggest office landlord pursues 'strategic default' to modify loan

The answer to your question all depends on the extent of the decline in this phase. Determinants of the outcome will likely be based on negative sum game theory and the gradient of decline as well as cultural factors. Yes, culture will play a big part in the final outcome IMO as the US, Chinese, Russian, European response etc will be strongly based on the psychological shock of it all and how people respond to that. Leadership will be vital in determining the outcome, affecting the herd's movement.

Since the debt crisis that's currently rocking Greece will eventually reach the shores of the UK, the USA and Canada, it seems useful to ponder what one would do with one's liquid assets if one were a Greek citizen right now. More specifically, would you:

1) Withdrawal some extra cash from the local bank (since there's been abundant anecdotal evidence of capital flight from the Greek banking system). What percentage of your assets would you leave in the banking system at this stage in a crisis?

2) Would you shift any existing bank deposits from a Greek bank to an international bank like HSBC that accepts retail bank deposits in Greece? I've read that Greek branches of HSBC have been overwhelmed with requests for new deposit accounts as Greek depositors have begun shifting their deposits from Greek banks to international banks.

3) Would you attempt to open a bank account outside the country and move your deposits there? If so, what percentage of your assets would you move?

4) Would you sell your short term government debt (since it seems a debt restructuring -- haircut -- is now inevitable.)

5) Would you buy some precious metals or US dollars in small quantities to hedge against the possibility that Greece will exit from the Euro and a return to a significantly devalued Drachma. (This would be a replay of the move that smart Argentinian investors made in 2001 when they converted their peso's to dollars before the fixed dollar-peso peg was lifted and the peso crashed.)

6) Stock up on extra emergency supplies of food/water/batteries/water filters etc. to prepare for the possibility that austerity protests could boil over into greater levels of disorder and civil strife.---------------------------

Since all of us will one day face the stress that the Greeks are currently experiencing, it seems useful to engage in these sorts of thought experiments well in advance of the actual crisis. Once the crisis strikes, it will probably be difficult to think calmly and clearly.

@Top Cat...liked your savings comment...trust is fundamental in all " working " relationship.

@ Ed Gory...yes, it is at least time to consider options. When I do so I keep hitting the wall of fudged data,secrecy, out and out lies. so am I supposed to take my pension to the casino and place my bet? On red...on black? All my chips on one spin or stretch out my stash hoping for a visit from lady luck. I often think of VK's " belief " in luck, that certain something that comes out of the blue...Your experiment is useful nonetheless. Each of us must make a personal call on how best to survive.Using Greece as a practice run is a good idea.In my case of limited resources, my choice is to stock up on items for barter,food and water... the decision made has increased my awaremess of such opportunities. For instance I noticed those butane fire lighters on sale for .99 ea. Picked up half a dozen...

Might I suggest stocking up on Vodka, Whisky, Rum etc and Cigarettes, they generally don't expire and are always in demand and are quite useful units of measurement :)

I recall that in pre 19th century, babies were given a slight amount of alcohol as it wasn't contaminated like the water.

Dmitry Orlov also recommends basic tools and bronze nails. Can never have enough bronze nails for construction and the like. Might I also suggest learning how to make your own soap, shampoo, perfumes, toothpaste etc. Not very difficult at all from what I've read and very handy to have around for smelly days. One can make a years supply in a few days.

I purchased this Alan Lomax compilation at a military base in Virginia about 50 years ago. Much of it is still available on Smithsonian labels using politically correct titles.http://vslam.com/music/negro-church-music/

I find it interesting that individuals like Roger Altman and the media in general will never point out the elephant in the room when harping on the deficits here in the US. And that is the amount that is spent on defense and war which is over 50% of the budget. Souper’s points at the beginning of this section more than adequately explain the problem.

Also, I for one resent hearing about Social Security being an entitlement; I have been paying FICA taxes my entire working life. It only becomes an entitlement if you live long enough to draw more than you and your employer paid in which is not certain. (Note-I don’t expect or am planning to see a dime of it in any event)

The blank stares of incomprehension when I try to make the same argument are really scary; so many here have been convinced by the media that they are in mortal danger and must be protected from “Terrorists” at any cost.

And if we are going to spend money we don’t have, better it be on things like this:

Some background; Garth has been denigrating those who wish to use high interest CDIC insured acounts (2%ers) to hold some of their dollars. Yet tells the following story:

-------- "For example, in 1996 I paid top dollar for a newly-renovated and expanded house on a good street in Leaside: $550,000. In 2000 I sold it for $625,000. " [Garth]

3.4% gross return? Next time maybe just take it easy and put it in Ally? [manana] ---------

I think the comment was fair, mildly humorous as well as useful. particularly for those who should be thinking about their own circumstances and safety needs. Judging the value of the advice, of these oft fallible mortals who wear thick impenetrable skins of Blog, should be always in ones mind.

Grab 'n' Go bags, fallout shelters, stashes of swag and all sorts of other disaster preps are one of our favorite pastimes.

The key question, of course, is not so much what to put into your carry-on luggage before boarding the Ark, but when to pack.

And both questions (What & When) very much depend on who you are. By that I mean, what are your druthers? Your strengths and weaknesses? Your age and sex?

If high value density liquidity (cash, gold and shiny rocks) is your thing, then better add guns and ammo to the list... because there are quite a few people who reckon the only thing they need after the fall is people to steal from.

If you're more the farmer type (like me) then its largely about having seeds, implements, a patch of ground, good water... and dependable neighbors.

The oldest advice on this sort of thing, though, comes from the Jews, who literally wrote the book on the subject: pack as much knowledge into your head as will fit, work like your life depended on it, and resign yourself to being dissed and bullied a lot.

Some folks reckon to amass stacks of the stuff they think they'll need for a post-civilization world, and others to avoid collapse altogether by miraculously saving the world from itself through political action and/or prayer.

The best I've heard, though, came from my daughter.

"People are going to do what they do, just go on living until further notice."

Regarding war: IMO the rulers of empire will not simply fold up their tents and go away. They will go out with both guns a blazen. The civil unrest they would be facing if they just allow resources to dry up and food shortages to mount would be worse than all-out nuclear war in their minds.

WW3 may be survivable for the elites if they have a safe haven in South America. Population must be dramatically reduced soon and they know it.

Great post sir, full of nuggets.Cigs and booze for barter.....of course, I'd never've thought of that, always demend there, like Scandia tho' I'd be doomed to eternal tepmtation. :)Not sure we're quite at that stage yet however, one for the future tho'.

One other thing I might add, is spices and silk cloth. I mean the whole point of Europeans sailing halfway around the world, enduring hardships and colonizing the planet was to make their food tastier and for the women to dress better!

That's why Colombus set sail for the US, that's why the silk road flourished for so long, that's why Vasco Da Gama was all over the world and Marco Polo was touring the world and meeting Kublai Khan. Aaah, days of grand adventure! When a trip to China took a few years rather then a few hours.

So stock up on spices, they last a considerably long time as well as fine silks. A little luxury goes a long way in times of hardship. :)

Might I suggest for those with a farming bone in your body to stock up on unfranken seeds as well. If you can still get those. Very useful to have seeds for planting for the next season as well as barter. Real value there chaps!

The answer to your question all depends on the extent of the decline in this phase. Determinants of the outcome will likely be based on negative sum game theory and the gradient of decline as well as cultural factors. Yes, culture will play a big part in the final outcome IMO as the US, Chinese, Russian, European response etc will be strongly based on the psychological shock of it all and how people respond to that. Leadership will be vital in determining the outcome, affecting the herd's movement.

April 23, 2010 12:38 AM"

VK for Christ sakes why do you talk like that, it doesn't help a conversation to attempt to be abstruse. Nothing you said could not be said in colloquial English. Who knows but there might even be some sort of meaning hidden in there. Give it a shot, it is called communication. You could as well give a reader another break and give more definition to your ' of it alls' and 'thats'.

It's either that pal or off you go to write derivative contracts for Goldman Sachs.

I don't smoke (never have)... so never pay attention to the price of cigarettes. Happened to be at the courtesy counter in the grocery couple weeks back. $60-70 a carton. I seem to remember thinking some of the brands were pushing $2 a cigarette at the "per pack" price. How do people afford this?

Already worth more than their weight in PM... and smoker or not in addition to not being able to eat it - I know you can't smoke PM!

A lot to like in your 12:09pm comment. Hoarding may be a fine idea for bridging a societal burp, but unless you've already got a foot in the grave, you will run out. Much better I think to figure out how to make do with whatever will be at hand. And of course try shaping what will be at hand.

Regarding the likelihood of rampant theft, I wrote this to my sister the other day. We've been Robin Hoodwinked and soon the woods will be full of robin' hoods.

BTW, I like the philosophical turn of your daughter's mind. I am sure she will be good to have around after TSHTF.

Spices are good, maybe medications for common ailments such as diabetes and heart conditions would be tradeable, first-aid kits and guides, assorted medicines to treat gastrointestinal distress from spice abuse and food poisoning, as well as painkillers. Perhaps there would be demand for other stress-relieving farmaceuticals, besides achohol and smokes, in case the government doesnt spike the water supply with valium to quell panic, or purified water if they do so exessively. And various skill books, repairable tools, some cosmetics, soaps, profilactics, and toilet paper, lots of it, also doubly-plied non-banknotes to wipe with. Not that I associate with hardcore survivalism, but some of these items might be handy to keep around for disaster barter.